Italian bonds: Diversification is key as uncertainty envelops the world
Mark Nash, Huw Davies, and James Novotny say a fixed income portfolio that blends Italian bond holdings along with an absolute return strategy with a proven track record would prove beneficial in the longer run.
Marketing communication for professional investors. Capital at risk.
The rise in yields seen in bond markets over the last few years has offered a significant opportunity for investors as fixed income markets have come back into play as a way to deliver long term performance to wealth management clients. However, unlike the period prior to the pandemic bond markets have not seen yields swiftly return to the lower levels experienced in the post Global Financial Crisis (GFC) environment as uncertainty over the stickiness of inflation and the outlook for monetary policy have remained. Macroeconomic volatility has truly returned.
Therefore, the challenge for wealth managers is how to access this higher yield opportunity while retaining control over the volatility of their fixed income exposure.
This is where Markowitz’s ideas around diversification are relevant, but often difficult to obtain in the world of bonds where volatility and returns have a high correlation across different fixed income exposures.
We believe diversified absolute return strategies can help diversify fixed income portfolios when bond market volatility remains high and yields sporadically experience significant retracements, helping improve risk adjusted returns.
Jupiter Strategic Absolute Return Bond (SARB) and Italian Bonds: A comparison
Source: Jupiter, Bloomberg as at end June (in percent).
With central banks around the world sharply boosting interest rates to quell inflation, various scenarios such as `hard landing’, `soft landing’ and `no landing’ have been doing the rounds. Market expectations of a steep cut in the interest rates by the Federal Reserve this year have been dashed as the US economy has surprised to the upside. This has had a bearing on the rest of the world and exemplifies the uncertain times that we live in.
In Europe, it’s a different story. The ECB effected its first rate cut in the current cycle in June as Europe’s growth impulses contrast with the resilience shown by the US economy. However, a return to the post GFC world of ultra-low interest rates looks increasingly unlikely.
Therefore, we seem to be in a world that existed pre-GFC of elevated interest rates, yet more uncertainty around the path of geopolitics and the security of international supply chains. Western nations woke up to the possibility of a lopsided world wreaking havoc on their economies during Covid as China reeled under the pandemic, disrupting global supply chains. Factors such as the increased rivalry between the U.S. and China, the ongoing conflict in Ukraine and Israel and rising oil prices all could influence the fixed income markets.
This is where active investors such as Jupiter’s SARB come into play, given its highly adaptable approach to market developments. SARB has been able to offer low volatility diversified return with low correlation to traditional markets. This offers a diversifying option for portfolios able to sit alongside more traditional fixed income exposures.
Investors have the option to combine traditional exposures (in this case BTPs) with SARB, given its diversifying characteristic that allows for improved risk adjusted returns. A well run actively managed fund can also provide a broader source of return along with lower volatility.
SARB (EUR) | BTPs TR | BBG Global Agg (EUR H) | 50% SARB, 50% BPTS | |
|---|---|---|---|---|
Cumulative Return | 13.68 | 5.02 | -3.33 | 9.76 |
Annualised Return | 2.17 | 0.82 | -0.57 | 1.57 |
Volatility | 3.19 | 7.18 | 4.17 | 4.05 |
Return/Risk | 0.68 | 0.11 | -0.14 | 0.39 |
(For illustrative purposes only. Past performance is no guide to the future)
The key to diversification is finding exposures that have low correlations with each other, even in times of high market stress. This allows investors access to higher yielding assets while controlling the delivered level of volatility to a pure exposure in that asset. The table and chart above show the significant effect in this regard of adding SARB to a portfolio of BTPS, reducing the portfolio volatility to an impressive 4.05%, much lower than BTPS in isolation and highlighting the true diversifying characteristics of SARB.
There’s no doubt that the attractive yields offered by BTPs have lured investors in recent years. However, given the elevated macro uncertainty, marked by the unpredictability of the path of interest rates, a portfolio that combines Italian bonds with an absolute return strategy would provide clients greater flexibility in managing their portfolio. The addition of such a fixed income fund to their portfolio, apart from keeping a lid on volatility, will provide the much needed diversification to navigate the emerging environment better.
Rolling 12-month Performance (%)
01 Jun ’23 to 31 May ’24 | 01 Jun ’22 to 31 May ’23 | 01 Jun ’21 to 31 May ’22 | 01 Jun ’20 to 31 May ’21 | 01 Jun ’19 to 31 May ’20 | |
|---|---|---|---|---|---|
Fund | 2.4 | 1.2 | -1.1 | 5.6 | 6.1 |
Benchmark | 3.8 | 1.3 | -0.5 | -0.5 | -0.4 |
Past performance does not predict future returns. Returns may increase or decrease as a result of currency fluctuations. The performance data shown does not take account of the commissions and costs incurred on the issue and redemption of units.
Source: © 2024 Morningstar UK Limited via FactSet. All Rights Reserved. Fund performance data for I EUR ACC HSC is calculated on a NAV to NAV basis, income
reinvested, net of fees. All information as at 31.05.2024 unless otherwise stated. Marketing communication for professional investors
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