Investors move into fixed income funds
They're not as obvious as the lines of people queuing to buy shares in the Agricultural Bank of China listing at the beginning of summer, but wealthy investors moving into fixed income investments are just as significant.
In an environment with historically low interest rates, wealthy investors in the United States and Asia have been pouring money into longer-duration securities, substituting three- and six-month US Treasury Bills with 10-year Treasuries or bond funds.
In Hong Kong, they have been supporting Hong Kong's new-found status as an offshore centre for renminbi trading by investing in the latest yuan bond funds issued in the city by Hopewell Highway Infrastructure, Haitong Asset Management and Bank of China.
Fixed income provides a set income that an investor receives when investing in a particular fixed income asset category. As long as the underlying credit, corporate or sovereign issuer of the bond does not default, then the investment is returned upon maturity alongside the coupon collected to date.
In effect, a fixed income fund is a mutual fund that invests in sectors of the fixed income asset class, including US Treasury funds, sovereign bond funds, corporate funds and maybe even high yield and emerging market funds.
Are fixed income funds a safe bet during market turmoil?
Yes and no, according to Anurag Mahesh, head of Global Investment Services at Deutsche Bank in Singapore. 'The different asset classes in the fixed income universe behave differently,' he says. 'It's a generalisation because there could also be differences on a fund-to-fund level. But typically, equities will fall the most because from a balance sheet perspective they are the lowest part of the capital structure.'
Before the financial crisis, wealthy investors were focused on generating a fair return from their portfolios. Post-crisis, risk has become of paramount performance and investors have moved away from product investing to portfolio investing, Mahesh says.
What this means in the context of portfolio diversification is that fixed income investing has begun to play a more important role for wealthy investors. It is typically low volatility investing: the investor holds risky asset classes, such as equities, but as a good portfolio diversifier.
Fixed income tends to be lowly or negatively correlated to asset classes such as equities. That gives good diversification benefits in terms of generating return, while reducing portfolio volatility.
Burkhard Varnholt, chief investment officer at Bank Sarasin, says fixed income suits those seeking a steady income. Into this category fall elderly investors who want to preserve their wealth with a predictable investment strategy which also generates assurance and principal protection.
Pension funds are also significant investors, and asset allocators trying to navigate their portfolios through turbulent times, allocating their assets in what they believe are up markets and protecting them in what they believe are down markets.
'When an economy is in the early stages of recession, investors are typically well-advised to allocate a portion of their investments into fixed income funds. When it looks dreadful and can't get any worse, what you want to get out of fixed income is related to an economic recovery,' he says.
From the present economic standpoint, and in the context of portfolio diversification and lessening volatility risk, a mix of fixed income investments makes sense.
Emerging market debt, hard and local currency denominated, has potential upside because from a demographic and economic standpoint, emerging markets will likely be in a better position in five to 10 years than the G3 economies.
Other parts of the fixed income universe, such as investment grade or high yield corporate credit funds, are also a good asset class to be in because the potential yield from credit risk is substantial in relation to the base interest rates in the market.
Returns in the fixed income universe can be divided into three sub-asset categories. First are the triple-A funds - such as US Treasuries or quasi treasuries and sovereign funds. The second includes corporate credit funds where the return is higher because the investor is assuming the credit risk of the corporate. These can be divided into two sub-categories, investment grade, usually rated triple-B or higher, and high yield, non-investment grade companies typically rated lower than triple-B-. The third category is emerging market debt investments in US denominated and local currencies.
'Many wealthy investors are looking at emerging market debt funds and it's clear that these will continue to be an important part of their portfolios,' Mahesh says. 'From an interest rate differential standpoint, central banks in emerging markets are going to be raising interest rates faster than you'll see in developed countries. That means that emerging market currencies will generally be on a strengthening trend, which makes the case for emerging market debt and local currency debt investments.'
