We wouldn’t use a screwdriver to chop down a tree or a hammer to cut a piece of glass to size. We make sure we choose the right tool for what we’re trying to achieve. So it is with investment.
The investment approach we follow should reflect the goals we’re trying to achieve. Using the same approach in all circumstances could not only mean we don’t achieve our goals but that we fall a long way short of them.
Arguably, this is what many clients experienced in 2022 when not only did equities post negative returns, but fixed income joined in resulting in many ‘lower-risk’ portfolios delivering double-digit negative returns.
Fixed income is a very diverse asset class and can be used to do several different ‘jobs’ for clients. The main ones are delivering growth, providing diversification, generating income and preserving capital. Of course, we will always expect our investments to deliver some level of growth, or why would we bother investing?
Fixed income is a very diverse asset class and can be used to do several different ‘jobs’ for clients
Our latest research titled Shaping Tomorrow’s Portfolios: The strategic role of fixed income shows that diversification is by far the main use for fixed income by advisers.
Nearly half (43%) of respondents said reducing overall portfolio volatility was the most important use and a further 16% chose offsetting equity market risk. But 18% said protecting capital in market downturns was their main objective and 21% saw income generation as the priority.
For lower-risk investors, allocations to bonds in multi-asset portfolios are expected to reduce volatility and help limit losses. But in 2022, many portfolios were holding longer-dated fixed income to pick up higher yields and generate some growth. Effectively, trying to do two jobs at the same time.
When yields quickly spiked, the inevitable consequence was that bond prices fell sharply and fixed income failed to deliver on both the jobs it was being employed to do.
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Advisers’ response has been to diversify across different types of fixed-income strategy, increase their use of strategic bond funds and make greater use of shorter-term bonds.
Strategic bond funds offer the flexibility to change allocations across fixed-income markets in response to changing market conditions and so could be considered to be a Swiss Army knife of bond investing – able to do multiple jobs with one tool.
Indeed, it is this flexibility of approach that strategic bond funds offer that is the main attraction for advisers. However, flexibility also carries risks and advisers remain wary that managers may still be running concentrated positions that could disappoint if circumstances don’t unfold as expected.
Another response has been for some advisers to increase their use of active strategies. Fixed-income indices are very different from equity indices in that a company’s weight in the index is driven by how much debt they have in issuance not how valuable their shares are.
It’s the flexibility of approach that strategic bond funds offer that is the main attraction for advisers
This perhaps provide more opportunities to add value through active management. Certainly, if we’re looking to manage downside risk or generate income then it is likely that an active approach will be preferable.
Looking forwards, it is this combination of generating attractive levels of income while preserving capital that is top of advisers’ wish lists. 42% of firms put this as a priority for product innovation in fixed income together with fixed-income products that could provide some element of inflation protection, an important feature given that inflation risks have increased in recent years.
The asset management industry needs to support advisers seeking to fulfil specific client goals by delivering fixed-income products that are aligned to client objectives rather than markets. Without that the danger is that we end up using the wrong tool for the job.
As Abraham Maslow observed “To a man with a hammer, everything looks like a nail.” With a bigger toolkit, we can make sure we can do all the jobs our clients need us to do for them.
Richard Parkin is UK head of retirement at BNY Investments
