Our approach to fixed income absolute return investing aims to generate positive returns over an economic cycle regardless of conditions. We are strongly focused on capital preservation, making our approach particularly suited to the current environment in which we have seen extreme movements in credit spreads, government bond yields and exchange rates.
We believe our absolute return fixed income strategy offers investors a way to diversify their portfolio due to its low correlation with traditional, long-only, bond strategies. For this reason, the strategy can help investors enhance the risk/return profile of their allocation to bonds. As such, we believe it should have a place as a core element in a long-term allocation to bonds.
The strategy has performed well over the recent volatile period, but before delving into this, here’s a recap of its principal objectives:
- A focus on capital preservation. Our strategy seeks to deliver a positive performance across the cycle and outperform cash by 250 basis points before fees, while limiting rolling 12-month drawdowns to no more than 2.5%. The portfolio is diversified to better manage downside risk and preserve capital such that it can generate performance in various market environments.
- The strategy has greater flexibility than a traditional long-only fixed income strategy since we can go long and short fixed income assets. This means it has a higher allocation to relative value strategies, and it does not have to be fully invested in any one asset class.
- The strategy’s capacity to exploit volatile conditions: Our strategy has flexibility with a symmetric -3 to +3-year duration range. This is lower than traditional fixed income benchmarks, which reduces its sensitivity to movements in interest rates. It enables us to exploit changing market conditions by taking both underweight and overweight duration positions. This helps when movements in interest rates are volatile as we saw in the first half of April. When volatility rises and there is dispersion in valuations between and within the different fixed income segments, there are more relative value opportunities for us to exploit.
- A diversified fixed income exposure: We can invest across the full fixed income universe using a global and unconstrained approach. With rising geopolitical risk, having a global opportunity set means performance can be generated from a range of return streams, both in terms of geography and asset class. The different segments of global bond markets we invest in are:
- Developed market sovereign interest rates
- Structured securities (such as the US mortgage-backed security market)
- Investment-grade and high-yield corporate bonds
- Emerging market (EM) debt
- Active management of currency positions.
How did the strategy fare amid the tariff turmoil?
First, it’s important to emphasise that in managing our strategy, we’re seeking to use all the expertise across the specialist teams for the segments within global fixed income that make up our investment universe to maximise the opportunities that our unconstrained landscape offers. We seek to ensure that we can construct diversified portfolios which perform well across a range of scenarios.
Amid the market volatility in the wake of the ‘Liberation Day’ US tariff announcements, our strategy came through well, highlighting its focus on capital preservation. Here is an overview of how the strategy navigated this challenging environment.
We came into the year with the view that US growth was already slowing and that asset markets were overpricing US ‘exceptionalism’. Outside of the US, several markets had already priced in a lot of the bad news after various surveys signalled that the health of the US economy was deteriorating.
We expected the hard data to begin to capture these trends, and the recent imposition of US import tariffs has only strengthened this view. The increasing risk of higher inflation looks likely to result in a stagflationary environment for the US.
Positioned defensively
Considering our views, we positioned the portfolio defensively, with short positions in corporate debt via short US investment-grade credit and short European high-yield credit to protect against a deterioration in global growth. Instead of owning corporate debt, we favoured US agency mortgage-backed securities which are higher in quality and provide an attractive yield.
The short positions in corporate debt were one of the main directional views in the portfolio. After the US presidential election, valuations of investment-grade debt spreads were at all-time tights, and the market was fully invested in the US exceptionalism story. We saw little scope for further price gains given the talk of import tariffs, slowing growth in the US and stagflation risk.
The positions contributed strongly to returns this year, particularly in April, as credit spreads widened significantly amid rising concerns over weak US and global growth, heightened uncertainty over the implementation of the tariffs and the prospect of stagflation. We used the widening of spreads to reduce positions, though our stance remains defensive.
Within interest rate strategies, we had a long duration bias, but preferred to express this via US and UK inflation-protected bonds rather than nominal bonds given the stagflationary risk. Overall, our duration strategy detracted from returns in early April. We benefited from the rise in US real yields to increase our position. We expect US real yields to fall as the negative impact on US growth from the tariffs becomes apparent.
We also held duration in selective EM local rates where yields curves are positively sloped and offer an attractive yield pick-up versus the cash rate. In the first half of April, our EM local currency exposure contributed to returns, particularly long duration positions in Brazil and Colombia.
In currency markets, as highlighted, coming into 2025 the market was well invested in the US exceptionalism theme. Given our view that this theme was overpriced, we sold the US dollar against a basket of EM currencies, euro-sensitive currencies and the Japanese yen, which traditionally benefits in risk-off environments. Overall, we believe it was a balanced basket to capture the decline in the US exceptionalism narrative. In April, overall currency returns were marginally negative. So far this year, however, currency positions contributed to performance.
Conclusion
Overall, the strategy delivered 2.1% above the cash rate over the year to the end of March. So far in April, despite the extreme volatility, it has delivered a further 0.3%, taking the year-to-date return to 2.4%.
Over a three-year period, the strategy has delivered a smooth and consistent return profile across various market environments, with limited drawdowns and an 2.6% annualised return above cash after fees.
We believe the positive performance of our absolute return bond strategy since the start of 2025 demonstrates the benefit of a diversified portfolio with contributions from several uncorrelated positions.
In the current environment, volatility brings dispersion within and between the different fixed income segments that make up our investment universe. By employing market neutral or relative value positions, we can take advantage of the arising opportunities.
The first half of April provided a real-time test of our investment approach. We are confident the strategy will continue to perform well given the opportunities available to us.
