Are yields changing the face of fixed income funds?
The not so diversified fixed income funds universe

By Cristian Balteo, Senior Product Specialist for Nordea Asset Management


Traditionally, the role of diversified fixed income funds within investors’ portfolios has been dual. While on one side, investors want to get reasonable levels of yield from them, diversified fixed income funds are also expected to deliver a certain level of protection when risky assets and – more specifically – equities struggle.

These diversified fixed income funds have the flexibility to invest across a very broad universe of fixed income sub-asset classes, such as government bonds, mortgage backed securities (MBS) and investment grade (IG) corporate bonds with an overall high credit rating level. Moreover, they also have the ability to tap into other higher yielding universes such as and high yield (HY) corporate bonds and emerging markets (EM) bonds, even if this type of assets is traditionally more risky/volatile and hence requires a different treatment from a portfolio construction perspective.

Over the past few years, as yields have dropped to the current historically low levels and investors have continued to chase returns almost at all cost, the more conservative sub-asset classes have been pushed to a much less prominent role in most diversified fixed income funds. Meanwhile, the more attractive HY corporate bonds and EM bonds – that can be wrapped around the HY credit assets denomination – have dominated the asset allocation of these products.

Thanks to liquidity being pumped into markets by very supportive monetary authorities, risky assets have been enjoying from an almost continuous bull market since the end of the great financial crisis of 2008.  This environment has been fertile ground for many portfolio managers who by simply tilting their portfolios towards HY credit assets have been able to deliver very attractive returns – from an absolute and risk adjusted basis.

Nevertheless, if we deconstruct the factors behind most of this positive performance, the underlying reality becomes very clear. HY credit assets have a naturally higher correlation with the economic cycle, as is the case for equities. Hence, they tend to perform very much in line with equities, especially when volatility spikes and investors dump risky assets in their search for safe heavens. The implication of this is that while most diversified fixed income portfolio funds are – as their name states – purely investing into fixed income assets, their behaviour increasingly resembles that of equities.

This presents at least two important issues that investors should seriously consider: First, the diversification inside these funds is now considerably lower, as they have dropped traditionally defensive assets, such as high quality government bonds, given their low expected returns, and have mostly concentrated on piling up HY credit assets that are highly correlated among each other. Second, the diversification these funds have historically brought to investors’ overall portfolios has also been considerably reduced, as HY credit and like types of assets are highly correlated to equities – the other big component of almost all investors’ portfolios.

At Nordea, we have a different approach when constructing diversified fixed income portfolios. For more than a decade now, Nordea’s Multi Assets Team has been building portfolios following what we call our “Risk Balancing philosophy”. Our approach aims to find the most attractive return drivers across two families of risk premia: those that are highly correlated to equities and those that are negatively correlated to equities. The idea is to make sure we build portfolios that – irrespective of the name-tag in the asset classes used – are structurally balanced between the two types of premia in order to be able to deliver on a pre-set outcome across the investment cycle without necessarily having to depend on making the right top-down macro call.

While this is a posture that might not have been very popular during the recent bull market years, investors would do well to ponder how prepared their portfolios are if equities – and equity-like HY credit assets – were to suffer a correction from their currently stretched valuation levels.

About Nordea Asset Management
Nordea Asset Management (NAM, AuM 223.6 bn EUR*), is part of the Nordea Group, the largest financial services group in Northern Europe (AuM 330.4 bn EUR*). NAM offers European and global investors exposure to a broad set of investment funds. We serve a wide range of clients and distributors which include banks, asset managers, independent financial advisors and insurance companies.

Nordea Asset Management has a presence in Cologne, Copenhagen, Frankfurt, Helsinki, London, Luxembourg, Madrid, Milan, New York, Oslo, Paris, Sao Paulo, Singapore, Stockholm, Vienna and Zurich. Nordea’s local presence goes hand in hand with the objective of being accessible and offering the best service to clients.

Nordea’s success is based on a sustainable and unique multi-boutique approach that combines the expertise of specialised internal boutiques with exclusive external competences allowing us to deliver alpha in a stable way for the benefit of our clients. NAM solutions cover all asset classes from fixed income and equity to multi asset solutions, and manage local and European as well as US, global and emerging market products.

*Source: Nordea Investment Funds, S.A., 25.01.2018

Nordea Asset Management is the functional name of the asset management business conducted by the legal entities Nordea Investment Funds S.A. and Nordea Investment Management AB (“the Legal Entities”) and their branches, subsidiaries and representative offices. This document is intended to provide the reader with information on Nordea’s specific capabilities. This document (or any views or opinions expressed in this document) does not amount to an investment advice nor does it constitute a recommendation to invest in any financial product, investment structure or instrument, to enter into or unwind any transaction or to participate in any particular trading strategy. This document is not an offer to buy or sell, or a solicitation of an offer to buy or sell any security or instruments or to participate to any such trading strategy. Any such offering may be made only by an Offering Memorandum, or any similar contractual arrangement. Consequently, the information contained herein will be superseded in its entirety by such Offering Memorandum or contractual arrangement in its final form. Any investment decision should therefore only be based on the final legal documentation, without limitation and if applicable, Offering Memorandum, contractual arrangement, any relevant prospectus and the latest key investor information document (where applicable) relating to the investment. The appropriateness of an investment or strategy will depend on an investor’s full circumstances and objectives. Nordea Investment Management recommends that investors independently evaluate particular investments and strategies as well as encourages investors to seek the advice of independent financial advisors when deemed relevant by the investor. Any products, securities, instruments or strategies discussed in this document may not be suitable for all investors. This document contains information which has been taken from a number of sources. While the information herein is considered to be correct, no representation or warranty can be given on the ultimate accuracy or completeness of such information and investors may use further sources to form a well-informed investment decision. Prospective investors or counterparties should discuss with their professional tax, legal, accounting and other adviser(s) with regards to the potential effect of any investment that they may enter into, including the possible risks and benefits of such investment. Prospective investors or counterparties should also fully understand the potential investment and ascertain that they have made an independent assessment of the appropriateness of such potential investment, based solely on their own intentions and ambitions. Investments in derivative and foreign exchange related transactions may be subject to significant fluctuations which may affect the value of an investment. Investments in Emerging Markets involve a higher element of risk. The value of the investment can greatly fluctuate and cannot be ensured. Investments in equity and debt instruments issued by banks could bear the risk of being subject to the bail-in mechanism (meaning that equity and debt instruments could be written down in order to ensure that most unsecured creditors of an institution bear appropriate losses) as foreseen in EU Directive 2014/59/EU. Nordea Asset Management has decided to bear the cost for research, i.e. such cost is covered by existing fee arrangements (Management-/Administration-Fee). Published and created by the Legal Entities adherent to Nordea Asset Management. The Legal Entities are licensed and supervised by the Financial Supervisory Authority in Sweden, Finland and Luxembourg respectively. The Legal Entities’ branches, subsidiaries and representative offices are licensed as well as regulated by their local financial supervisory authority in their respective country of domiciliation. Source (unless otherwise stated): Nordea Investment Funds, S.A. Unless otherwise stated, all views expressed are those of the Legal Entities adherent to Nordea Asset Management and any of the Legal Entities’ branches, subsidiaries and representative offices. This document may not be reproduced or circulated without prior permission. Reference to companies or other investments mentioned within this document should not be construed as a recommendation to the investor to buy or sell the same, but is included for the purpose of illustration. The level of tax benefits and liabilities will depend on individual circumstances and may be subject to change in the future. © The Legal Entities adherent to Nordea Asset Management and any of the Legal Entities’ branches, subsidiaries and/or representative offices.

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