Fixed Income: going global to stay short-dated

However, stepping out of cash usually means taking on duration. Some investors are wary of doing that in an environment expected to be more inflationary and volatile for the foreseeable future. 

Our short-dated enhanced income strategy is designed with that concern in mind. 

Figure 1: The thinking behind our short-dated enhanced income strategy
 

*Targets are offered as goals and are not referenced to past performance. There can be no guarantee the targets will be achieved.

Reaching wide, aiming for  low risk

The strategy is our lowest-risk fixed income product outside a money market fund, but it reaches globally for yield.

In fact, one of the things that differentiates us is our global approach.

Our peers in the UK, Europe and the US tend to run their short-dated strategies more narrowly, often investing almost exclusively in European corporate or government bonds, with heavy allocations to sectors such as European banks.

We use our wide global coverage to look for risk-adjusted yield, while staying within a very short-dated, low-risk structure.

Portfolio construction

Duration is held within a one-to-two-year parameter, and the portfolio fund must maintain an average credit rating of A- or better.

Figure 2: Short-dated enhanced income strategy portfolio construction

The portfolio also differs in what it can hold at the very short end. A traditional UK short-dated benchmark runs from one to five years, so a bond drops out of the index once it falls below a year to maturity, and a tracker then has to sell within one to three months. We can continue to hold it, although active managers rarely keep more than 10% of a fund there. By contrast, our short-dated enhanced income portfolio always holds at least 30% in assets with less than one year to maturity. This includes government bonds and a substantial allocation to corporate debt.

With roughly 14 months to maturity, a bond pulls to par and, if it is not defaulting, movements in spreads and interest rates no longer matter. This locks in a yield over cash.

Case studies

The following four holdings – a UK water company, a US software group, a Japanese e-commerce business and a Chilean copper miner – give a sense of our portfolio’s range.

Anglian Water

In the UK, where the water sector is under considerable pressure, the mid-tier and better-quality names are mispriced and still offer good value at the short end. Anglian Water had performed well over the past 18 months before struggling a little this year. Set against the quality of the regulated sector globally, even with its troubles, the spread and yield on offer still appeal.

Salesforce

In the US, we hold Salesforce, which we bought at its debut issuance in the US market a few months ago. Software has come under pressure over the past year on the view that AI will make much of the sector obsolete within a couple of years. This is not necessarily true: some companies will go, but many will not. The bonds came cheap because of the software premium priced into the market. For an A-rated credit with no concerns about the viability of the business over the next five years, it's now a core holding in our strategy.

Rakuten

We've held Rakuten, the Japanese e-commerce group, since the strategy launched just over three years ago. Its mobile business was a challenge some years back but has returned to growth. We like the economics of the e-commerce side, which has grown strongly across Asia and Europe and seen its share of M&A. It's a high-yield name, but the ratings look stable and the spread and yield are attractive. With about a year to maturity, it still offers value.

Codelco

Codelco, the Chilean copper miner, is a more recent holding. We remain positive on the copper cycle over the medium to longer term, with the quantity of high-grade copper required for new technology exceeding what is available. We also view the Chilean mines as good quality. We invested in three-year bonds carrying around a 30-basis-point advantage over equivalently rated BBB names in the US.

Final thoughts...

Stepping out of cash need not mean stepping out along the curve. The alternative is to go wider rather than longer.

This article was originally published in Investment Week.

Companies selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance.