Seahorses are terrible swimmers; they are also the slowest of all fish. When the sea currents get too rough, they might even die of exhaustion. For this reason, they anchor themselves by grasping onto corals, seaweed or any vegetation.
Is there still a role for fixed income in the portfolio?
For many years, fixed income has served as an excellent bedrock on which investors can then access the higher growth and more volatile equities. In addition, the declining interest rates in the Greenspan years have also provided an extraordinary bumper crop of yields for this asset class.
However, with rates at all-time lows, even negative in some economies, the bond bull run of the last decade has come to an end. The central banks’ quantitative easing programs have also inadvertently distorted the debt-equity correlation, calling into question the diversifying role of fixed income.
The rise of credit and alternative debt
Despite the relative unattractiveness of fixed income, there remains a need to control risk in the portfolio for investors going heavily into equities at current valuations. It’s also possible to add credit risk to a bond portfolio to improve yield – a move that is increasingly popular with investors.
Beyond investment grade credit, there is no shortage of credit in various quality, characteristics and geographies, including:
- Private credit and direct lending
- Emerging market debt
- Infrastructure or real estate debt
- Distressed debt or special situations
- Unconstrained or absolute return credit
The various credit strategies will certainly help with income, but the trade-off here is that credit offers less protection in a bad market, given its closer correlation to stocks. Consequently, how does the investor blend these possibilities to anchor the income and risk objectives?
Portfolio construction: Yield vs risk management
In addition to its shortcomings, the seahorse’s long snout constraints its ability to consume food quickly. This means that it must eat constantly to stay alive. Against all odds, the seahorse thrives by relying on stealth and camouflage to ambush its prey that floats within striking distance – doing all these while staying anchored in a turbulent environment!
The benign and uncertain economic environment, exacerbated by central banks’ intervention, has encouraged investors to hold riskier assets. While it may seem logical to abandon traditional fixed income in place for the plethora of credit and esoteric strategies, the need for appropriate portfolio construction and risk management becomes more pressing than ever.
At this 6th annual forum for fixed income, credit and currency professionals, we endeavour to evaluate the breadth of credit and alternative debt strategies, in the context of investors’ asset allocation policies.Enquire about this event