Investors have little confidence in fixed income managers’ ability to navigate the market conditions that lie ahead, according to a survey from NN Investment Partners.
The data, which consisted of answers from 103 international institutional investors, found that only 3 per cent are completely confident in fixed income managers’ abilities to cope with the impending rate hikes, while 6 per cent have no confidence in them at all.
The impending interest rate rises from the Federal Reserve have been a big worry for bond investors, as yields are already low and this could leave the asset class vulnerable to even a modest rate rise.
Sylvain de Ruijter, head of global fixed income at NN Investment Partners, said: “The current environment is very different from the last US tightening cycle, given the long period of very low interest rates and extensive quantitative easing that we have seen.”
“A Fed tightening cycle, if it comes, may well be very different from earlier cycles, something that few fund managers have experienced. The challenge will be to understand what is going on and to adapt.”
The asset management company’s research also found that, out of those who had little or no confidence in fixed income managers, half of them attribute this to the fact that few managers have dealt with the end of a credit cycle before, while 17 per cent said a lack of experience in rate rises was more concerning.
FE data shows, for example, that the past 25 years or so have been a very good period for bond investors.
Performance of sectors over 25yrs
Source: FE Analytics
The IA UK Gilts and IA Sterling Corporate Bond sector averages have returned 312.48 per cent and 355.13 per cent over 25 years, but have had maximum drawdowns – which show the most an investor could have lost if they had bought and sold at the worst possible times – of just 13.95 per cent and 17.83 per cent, respectively, over that time.
But thanks to the high valuations on offer (while at the same time) an uncertain outlook, Neil Jones (pictured), investment manager at Hargreave Hale, believes there is no doubt that the fixed interest sector will be a tough area to makes money from over the next few years, when interest rates will presumably rise. 
While he says that many managers are likely to do a good job against the wider fixed income market, investment opportunities will be limited if the whole sector slumps.
“There are a lot of decent fixed income managers out there, so I don't have specific concerns as to the skill set available. However, we have been in unprecedented times over recent years for this sector, so the exact nature of how the fixed interest market will react is highly uncertain,” he said.
“Couple this with continued uncertainty as to exactly when interest rates will rise and the speed at which further rises will happen, and it makes this a very unpredictable area for investors.”
While some managers will have been around during the last rate rise in 2006, Informed Choice’s Martin Bamford points out that this time is completely different as markets have been driven by quantitative easing, and few fund managers have experience of QE ending.
“I have little confidence in the ability of most fixed income managers to accurately call the timing of a rate rise. Many have consistently failed to get this right over the past two or three years, with expectations of a rate rise here and in the US continually pushed back,” he said.
“That said, it possibly doesn’t matter too much whether a manager can get this absolutely right. What is more important is a willingness to adjust a portfolio as the probability of a rate rise improves.”
The managing director’s sentiment appears to be shared by many other institutional investors, as 80 per cent of those surveyed by NNIP say that fixed income managers will have to adopt a more flexible approach to achieve positive returns.
Meera Hearnden, senior investment manager at Parmenion, says that flexibility is generally preferred, but should not be adopted at the expense of increased risk.
“If, for instance, some managers focus on managing gilt portfolios or just investment grade credit, then this means they are less likely to take advantage of opportunities in other areas of the fixed income market,” she explained.
“This is why we have increased exposure to strategic bond managers over the last year who we feel have the ability to navigate the entire fixed income markets and take advantage of the opportunities as they arise.”
Ryan Hughes, multi-asset manager at Apollo, says that many investors assume that strategic bond funds have the inbuilt flexibility to make money, but that this isn’t necessarily the case.
Certainly, in 2015’s difficult conditions, the IA Sterling Strategic Bond sector has returned just 0.29 per cent while close to 50 per cent of its members are in negative territory year to date. On top of that, just over 20 per cent of the peer group has had a maximum drawdown of more than 5 per cent year to date.
Performance of sector in 2015
Source: FE Analytics
“When looking at the IA Strategic Bond sector, it can be broadly split into three groups; those that have a permanent bias to government bonds and high quality corporates, those that have a permanent bias to high yield and then those that are truly strategic and have the skillset to make use of the flexibility,” he said.
“This group is small in number, unsurprisingly because the skillset required to invest in government bonds and high yield bonds is very different. The challenge for investors who need exposure to bonds is to identify those managers that fall into the genuinely skilful managers that will be able to operate in such a challenging environment.”
Some investors have focused their attentions on high yield bonds to receive more cushioning from the effect of a rate rise, due to the tight spreads traditionally investment grade fixed income assets are offering.
According to data from FE Analytics, the IA High Yield sector has also managed to outperform compared to other fixed income areas of the market, having returned 1.32 per cent since the start of the year while UK gilts and sterling corporate bonds have lost money.
Performance of sectors in 2015
Source: FE Analytics
The NNIP survey, however, found that 17 per cent of institutional investors questioned had little to no confidence in high yield managers’ abilities to weather the impending storm either, with only 2 per cent instilling complete confidence in them.
However, around half of the investors said that it will produce a mixed bag, with some managers coping well while others struggle as the market tightens. 29 per cent of those questioned thought that high yield managers would generally cope well.
Ben Willis, head of research at Whitechurch Securities, says that his chosen tactic is to remain with tried and trusted bond managers that he has been investing in for several years through different market conditions.
“Our view is that no-one knows when [the rate rise] will happen and so the uncertainty facing bond markets and bond fund managers continues,” he said.
“Over the last couple of years we have been reducing our bond exposure gradually where appropriate and allocating to other areas. However, we still seek bond exposure for yield and it can still aid diversification.”
In a follow-up article, FE Trustnet will explore the fixed income funds that financial professionals recommend for weathering rate rises.
