Article written by Thierry Crovetto & Pierre-Yves Dittlot from TC Stratégie Financière
Barring any significant political changes and unforeseen events occurring in developed nations, the main factor affecting financial markets in 2016 will have been the end of the sovereign-bond bull market. After 35 years, this tremendous performance driver appears to have come to the end of the road. Absolute return UCITS funds are a viable alternative to investing in bonds in a very low yield environment with rising interest rates and signals of increasing inflation on the horizon.
At this time, widespread non-conventional monetary policy implementation from main Central Banks has dragged sovereign and even some corporate bonds, into low or even negative-yields territory (the lowest in history!). Many investors were justifying such low levels by the weakness of inflation, high liquidity and the safety of these bonds. Moreover, a number of institutional investors, in order to comply with prudential ratio constraints, have been compelled to invest in government bonds whatever their yield.
The sovereign and high investment-grade corporate bond “bubble” could burst with the return of inflation. Conversely, inflation appears to be the only solution to solve the world’s high level of public debt problem. Protectionism measures promised by Donald Trump are also of an inflationist nature. For these reasons, we feel the time has come to diversify exposure to bonds by adopting other uncorrelated investment strategies. Absolute return solutions, through the use of Alternative UCITS Funds, are part of such solutions. Nevertheless, investors in absolute return funds have been disappointed by the wide disparity of their performances this year.
Within an absolute-return fixed income strategy implementation, it has become increasingly difficult to find assets offering an attractive risk-adjusted return. You can isolate a few funds with an attractive profile due to their flexible approach, with a performance that is replicable in the future, even under interest rate increase constraints. However, other absolute return UCITS strategies can provide additional diversification with a low correlation to the bond market. This is probably the best starting point to find a solution that copes with the current low-yield environment all the while improving Performance / Absolute Maximum Drawdown ratios.
At the same time, the implementation of a viable risk-adjusted return strategy, through absolute return fund allocation, has been rather arduous recently because of the complexity and heterogeneity of the universe and the wide dispersion of performance between winners and losers. Bearing this in mind, the use of quantitative filter allow to avoid any emotional bias and guaranty a stable investment process over time. The strength and the relevance of a quantitative filter reside in their implementation.
2017 will most certainly be a challenging year. It will probably start with strong US growth and higher inflation perspectives. Bond Duration will carry a greater risk of negative performance in the short term. In the medium to long-term, Trump’s program, particularly regarding trans-pacific partnership policy and higher taxes on imported goods, may well bring on a number of problems facing the global economy. The quest for performance almost certainly transits through a greater flexibility and effective risk management.
About the authors
TC Stratégie Financière SAM is an asset management company based in Monaco. As a firm that is closely-connected to the academic field, our approach focuses on research leading to both asset allocation advice and more complex quantitative models. From advisory mandates to “white label investment products”, we seek to maximize investment performance while minimizing drawdown. www.tcsf.mc