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Which bonds bounce best? A Citywire study

It's been a trying time for all sorts of bond strategies, be they Alt Ucits, traditional or flexible, so let's find out who best rolls with the punches.

Facing up to fixed income hardship

Global bonds have been an investor staple for many years but as the search for yield has grown more difficult new products have been launched to try and take up the slack. After the financial crisis of 2008 Alternative Ucits bond funds entered the market.

These hedge fund-like strategies aimed to minimise losses in market downturns, while still being able to generate alpha and protect capital. Another contender for investors’ capital has been flexible or diversified global bonds, which are able to invest in all parts of the long-only bond spectrum.

The majority of these flexible funds are heavily exposed to the higher yielding and riskier parts of the bond market, such as high yield bonds, convertibles and asset-backed securities.

In this analysis we take a closer look at how these three bond categories have fared over the three years from 2013–2016 in terms of flows and performance.

Figure 1 shows quarterly net flows over the three-year period to the end of 2016 for each category of bond fund. In Q2 2013, the first white arrow in the chart indicates sudden outflows from global bonds during the ‘taper tantrum’.

A similar pattern emerges in the build up to the Fed interest rate hike in 2015, indicated by the second arrow. During these events the two non-traditional bond sectors maintained their inflows.

However, in Q4 2014, when there was huge market volatility as QE ended in the US, Alt Ucits bond strategies proved very unpopular and investors started to withdraw their money. It’s at this point that flexible bond funds appear to pick up the baton. So were investors right to pull out of these long/short bond strategies?

So how does performance stack up against investor flows? The chart from Figure 1 has been split into two time periods (Figures 2 & 3) so it’s easier to see. Figure 2 shows quarterly flows and performance of all three bond categories over 2013-14.

In Q1 2013, global bond performance (indicated by the diamonds) was positive and as a result, in the following quarter, we saw more money pouring into global bonds with around €20 billion of net inflows. But performance in the following quarter turned negative for global bonds and flows here plummeted as a result.

If we look at the following eight quarters in 2015 and 2016 (Figure 3) – it’s a similar story after Q2 2015, where bond flows dive as a result of poor performance in the previous quarter. However, this analysis shows that traditional global bonds recover relatively quickly in flows and performance after down periods.

It’s also clear that flexible strategies provided more stable performance in all quarters analysed. This could be because they are invested in a broad range of bonds like high yield, EM debt and even mortgage-backed securities and are therefore able to adapt more readily to changing markets.

For both traditional bonds and flexible strategies, it appears investors were too quick to withdraw when performance was poor, because these are the sectors that rebound back more quickly. This reaction may be unwarranted as Figure 4’s risk/reward profile below shows.

Figure 4 illustrates that Alt Ucits bonds didn’t deliver on a return basis over the last three years. They may have lower risk than the other two categories, but flexible strategies have the best risk/return profile and global sovereign bonds are not far behind.

In summary, investors should be less reactive to global bond performance. Flexible/ unconstrained products and traditional sovereign global bonds have both proved their worth and recover more quickly in terms of flows and performance after a market sell-off.

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