Why Short Duration strategies are a good option in this market environment
Last year was a strong one for fixed income total returns, despite the persisting low yield environment pushing some investors to question whether there is still any value in the asset class. Fixed income’s recovery from the poor returns of 2018 is a sign of its resilience in this market environment, and we believe short duration strategies are potentially a safe bet for the coming period.
Monetary policy on hold, reduced macro uncertainty
The Federal Reserve (Fed) cut interest rates 3 times in 2019, but monetary policy is on hold in the short-term. The American central bank has signalled an extended pause in 2020 as it watches how the US economy evolves, while improving economic data seem to have reduced the likelihood of a recession. In Europe, the new head of the European Central Bank, Christine Lagarde, inherited a non-conventional monetary policy made of zero interest rates and a government bonds purchasing program from her predecessor, Mario Draghi, who left on October 31. We expect monetary policy to be on hold for the foreseeable future.
Since the financial crisis of 2008-2009, central banks are keeping the expansion going, but there are clear structural weaknesses in some economies, for example Germany and Italy.
Source: Refinitiv Datastream 21-01-2020: GDP data from Organisation for Economic Cooperation and Development World Economic Database.
At macro level, there is strong consensus in favour of a modest cyclical rebound in global activity in the first half of 2020 as a result of supportive monetary policies and reduced uncertainties around global trade and Brexit. Investor concerns about the risk of a global recession have eased and a mood of “cautious optimism” prevails. However, the US elections will test investor sentiment again later this year.
Our view is that slightly better economic data, reduced macro uncertainty, and more government issuance can push bond yields higher in the short term.
Why Short Duration now?
Short duration looks like a very attractive fixed income strategy in the current environment, particularly in high yield. Once we have a bit more clarity about the impact of the coronavirus, there is a potential for bond yields to rise 20, 30 or 40 basis points*. Across our range of short duration strategies, performance has been strong (see table below).
Source: Bloomberg; BofA/ICE Bond Indices; AXA Investment Managers 21-01-2020
*Source: AXA IM as at February 2020
What are the benefits?
Low sensitivity to interest rates movement
Short duration bonds are bonds that have a shorter time to maturity, typically less than five years. Due to their shorter time to maturity, they are less sensitive to interest rates movements. While we currently face a very low (and in some countries negative) interest rate environment, should central bank policies prove to be successful and global growth picks up, investors are likely to face rising interest rates. Interest rates and bond prices usually move in opposite directions, therefore rising yields could have an adverse impact on bond prices. Due to their shorter maturities, short duration bonds can mitigate losses in periods of rising interest rates, as cash flows from maturing bonds can be reinvested at higher rates in the market.
- Ability to mitigate the impact of market volatility
By the nature of a lower duration and spread duration, short duration investing offers lower volatility and drawdowns when compared to the wider, all maturities markets. Short duration bonds are less sensitive to credit spread movements compared with longer duration bonds, implying lower volatility of returns than the broad market. This is predominantly because the price of bonds that are closer to maturity tends to be close to par than longer duration bonds, and the discounted value of coupon payments is less sensitive to changes in interest rates.
- Maintain a high level of liquidity during stressed periods
Exhibiting a naturally attractive liquidity profile, due to regular cash flows from maturing bonds and coupon income, enables a short duration strategy to minimise turnover when implementing active strategies. Holding bonds until their maturity also implies lower transaction costs, which can improve returns over the long term. Fixed income indices traditionally exclude bonds with maturities of less than one year.
- The risk versus return profile
In a low interest rate environment, short duration bonds can offer an intermediate step into riskier asset classes for investors seeking incremental yields. Investors may consider looking beyond domestic markets towards Asia, high yield and emerging markets, where short duration products can offer an attractive risk-return profile.
AXA IM’ short duration bond strategy range
AXA Investment Managers offers a range of short duration strategies which aim to meet your needs, whether you are looking for a higher yield or to combat inflation. Our short duration strategies generally invest in bonds with maturities of five years or less and seek to capture high current income with low overall volatility. The result will be portfolios with a duration that is generally under 3 years.
“Our Short Duration strategies are a potential safe play in this market environment where volatility prevails over directionality. They will allow investors to benefit from the most appealing carry opportunities,”
Marion Le Morhedec, Head of Active Fixed Income Europe and Asia
For investors looking for income opportunities across the entire global short duration bond spectrum, while aiming to mitigate market volatility.
Global Short Duration
- Investment Grade
For investors looking to take the first step in the credit ladder. These strategies can offer a yield enhancement to a cash alternative, while at the same time aiming to minimise overall volatility.
Sterling Credit Short Duration, US IG Credit Short Duration and Euro IG Credit Short Duration
- High Yield
For investors seeking the opportunity to capture an attractive income and carry from the high yield asset class, while mitigating volatility.
US Short Duration High Yield and Europe Short Duration High Yield
- Emerging Markets and Asia
For investors looking to participate in diversifying asset classes through a volatility mitigation and high carry strategy.
Emerging Markets Short Duration, China Short Duration and Asia Short Duration
For investors that are seeking an opportunity for income from euro-denominated government bonds and corporate debt with reduced sensitivity to interest rates
For investors looking to mitigate the impact of both inflation and volatility on their portfolio, while participating in a diversifying asset class.
Global Inflation Short Duration
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