Fixed Income

Solving the income portfolio construction puzzle


Mihkel Kase

Mihkel Kase

Fund Manager – Fixed Income and Multi-Asset

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The recent launch of our new active ETF, the Schroder Absolute Return Income (Managed Fund) (Chi-X Code: PAYS), was an exciting development and part of our strategy to broaden access to investment solutions in a variety of formats and platforms. PAYS is a new point of access for our unlisted strategy, the Schroder Absolute Return Income Fund.

We are not alone in offering an exchange-quoted product. We have seen something of a proliferation of new listed, quoted and unlisted investment products attempting to solve the income challenge. However, the exposures and design of these can vary significantly in terms of risk, asset types, management approach (active and passive), liquidity … the list goes on.

While it has arguably become easier for investors to access exposures, that doesn’t necessarily solve the portfolio construction challenge in the search for income. When accessing any investment, investors need to be clear about the role it will play in their portfolios. Is it a defensive asset or more of a growth asset? Is it designed to hedge risk or does it amplify it? How does it behave across different market environments? With some of the new offerings having limited track records, the answers to these questions may not be immediately obvious.

The portfolio approach we use is an active one, enabling us to manage risk through different market cycles. It is also global by design, allowing  us to access opportunities where they present. Importantly, with a risk managed approach, the defensive characteristics remain a key focus. How you combine assets and manage the overall risks through the cycle remains the key to delivering appropriate outcomes.

Outlook brightening, but some storm clouds remain

So how do we see the current investment landscape?

2019 to date has been a positive year for most asset classes. Despite the ongoing uncertainty from the trade war and Brexit, central banks have been cutting rates and injecting liquidity when and where required, which has kept volatility relatively subdued and pushed out the risk of recession. While we see the economy as late cycle, there appear to be some early indications that global growth may be reaching the bottom, with the potential for a modest recovery.

Our portfolio settings

While we will continue to look for confirmation of these signals, we have made several portfolio adjustments over the month. In terms of credit, we continue to carry higher quality exposures. This is expressed through holding predominantly investment grade credit exposures along with a small short in global high yield. That said, over the month we continued to diversify our credit exposures by starting to add securitised credit. These instruments have a cash-plus return target and provide exposures to a range of underlying offshore assets that provide a more direct linkage to the consumer, rather than direct corporates. The aim is to add yield to the portfolio while also further diversifying the credit exposures.  

We continue to hold exposure to the Schroder ISF Emerging Market Debt (EMD) Absolute Return portfolio. This provides additional diversification and active exposure to local and hard currency emerging market sovereigns. The cash-plus return target and focus on risk are consistent with the portfolio objectives. At this point we prefer the absolute return approach to a more EMD beta driven portfolio. 

On the duration side, we have been reducing the interest rate sensitivity of the portfolio. This has been driven in part by the rally in bonds, but also by the view that an improved global growth outlook could put upward pressure on bond yields and hence downward pressure on bond prices. We do, however, retain some duration in the portfolio for its defensive characteristics, with the main positions being 0.6 years in Australia and 0.4 years in the US. We also maintain some inflation protection.

On the currency side, we continue to hold exposure to the USD to assist with managing downside risk. Typically, in ‘risk off’ phases, a flight to quality can support the USD and can therefore assist in portfolio diversification. This is particularly relevant, as we have been cutting duration and hence we will continue to look to currency to support the defensive role duration plays.

Overall, our expectations have become somewhat more positive, with some tentative signs of improvement in the global growth outlook. As such, we have been adjusting portfolio positioning but retaining our diversified, liquid and defensive posture. Current market valuations still warrant caution, so we have been ’trimming the sails’ rather than changing course on portfolio positioning to navigate the challenging market environment ahead.

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