Absolute return – thinking differently about bond funds

Michael Lake, Fixed Income investment director, Multi-sector at Schroders Investment Management takes a look at absolute return bond funds, and exploress how a strategic approach could better protect capital without sacrificing growth.

Bonds are still essential, but investors may not be aware of the risks
Bonds are still an essential part of building a diversified portfolio. As investors come to rely on their investments to meet liabilities, bonds often play an increasingly significant role in protecting capital and generating a predictable income stream. This traditional approach to portfolio construction remains true today.

However, while bonds still have a crucial part to play, today’s macroeconomic environment means that using only traditional bond funds may expose investors to more risk than they are aware of. Throughout the summer of 2015, headlines in financial media were focused on the Greek debt crisis and steep falls in the Chinese equity market.

These stories did cause volatility to rise in bond markets, but from a structural point of view, neither is currently
expected to pose a serious threat to market stability. For bond investors, the most prominent threat is posed by an otherwise positive development: the global economic recovery. In particular, the economic recovery in the US is likely to drive a profound change in the accommodative monetary policy environment that has supported bond markets since 2008.

The story so far…
In response to the global financial crisis, the Federal Reserve (Fed) – central bank to the world’s largest economy – dropped its headline interest rate to almost zero. In addition, the Fed also eased monetary policy in a way never seen before; introducing a series of massive quantitative easing (QE) packages that injected a total of $4.5 trillion into the US bond market. Treasury yields during that time fell to all-time lows, and as a number of major central banks enacted similar asset purchase programmes, many other bond markets followed suit.

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