The top 5 questions asked by fixed income investors


1. With today's low cash rates and compressed credit spreads, the search for income can be challenging for investors. How much risk should investors be taking in the hunt for yield?

One of the challenges facing investors today, particularly in the fixed income space is where to find yield and how much risk to take. Credit spreads have become compressed and cash rates are very low, so investors are scrambling to find alternatives to their previous income mainstays (such as term deposits and hybrids).

As a result, some investors are going further and further out on the risk spectrum. While there are assets providing some relatively attractive yields, there are risks that also need to be considered. For example, global high yield provides a source of income but can have equity-like volatility in market downdrafts and hence may not behave in a defensive manner. Rather than buying single asset classes that appear to deliver an attractive yield, we believe constructing a globally diversified portfolio is a better solution. Managing credit risk, interest rate exposure and currency exposures should be front-of-mind for investors seeking defensive income sources.

2. Do you expect the US Federal Reserve to accept more volatility in the markets?

The effects of loose monetary policy settings and massive amounts of fiscal stimulus coming through the US economy is starting to generate some inflation. As a result, we're now seeing the market pricing in likely removal of quantitative easing and a potential transition to higher rates by the US Federal Reserve. The uncertainly around the timing and pace of the adjustment is resulting in some volatility coming through markets, which won't be welcomed by many investors.

Central banks would like to have an orderly transition, but still expect bouts of volatility that accompany that adjustment process. We expect they will try to quell volatility to an extent, but how successful they are will depend increasingly on the economic fundamentals as we move through this next market phase.

3. The Chinese property market has been contributing to some of the rising volatility. Do you expect this stress to impact other global property markets?

We do have exposure to property via our Schroder ISF Asian Credit Opportunities Fund, but we don’t have  exposure to the Chinese property developer, Evergrande. We are conscious of potential contagion within the Chinese credit market and that default risks have risen. While Evergrande did make its recent coupon payments, questions around solvency will see continued volatility in the property market. That said, if you look at the risk premium within those segments, arguably there is a lot already priced in.

In terms of the bigger picture, ongoing volatility may impact other sectors within the Asian credit market, however we believe it will be relatively contained. We don’t expect it to leak into other global property markets and become a systemic issue.

4. Given the concerns about rising inflation, what are you and your team doing in managing the Schroder Absolute Retun Income Fund portfolio?

We’ve been adjusting the global credit components and de-risking the portfolio as part of our normal portfolio management process as valuations have become quite full in many areas. We are running low levels of duration so the sensitivity to rising interest rates is very low. We are short duration in the US and we have a long duration position in Australia to take exposure to interest rate differentials between those two markets. We are also using currencies to provide downside risk management, particularly where duration is challenged. Cash is currently elevated which provides liquidity and the ability to take advantage of opportunities as they arise.

5. Is now a good entry point for adding more duration in your portfolio – and how much should you add?

With uncertainty around the growth and the inflation outlook and the timing and pace of interest rate rises, at this point in time we still advocate low levels of duration, particularly in absolute return focused portfolios.

As interest rate markets move through this adjustment phase towards more appropriate settings, bouts of volatility are likely. This will bring opportunities to reset the portfolio on a more positive duration footing. We can then deploy cash holdings and add duration to take advantage of term premia as it rebuilds and longer dated bonds in the sovereign space provide better value.

Click here for more on the Schroder Absolute Return Income Fund or active ETF the Schroder Absolute Return Income (Managed Fund), ticker: PAYS

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