Investors urged to reconsider bonds

New financial products are opening the way for superannuation funds to use the fixed income component of their portfolios to boost alpha returns rather than relying predominantly on equities and property for their non-market movement income generation.

“Australian funds typically have a very heavy emphasis on equity managers to deliver the bulk of alpha return on their portfolios, often aiming for 80 to 90 per cent of the portfolio’s above market return to come from equities and property, ING Investment Management head of fixed income James Wright said.

Derivative offerings are particularly effective in facilitating these strategies and have brought about the use of global fixed income markets for additional alpha returns.

Credit default swaps and credit index swaps are two products in this space enabling fixed income managers to manufacture a range of alpha overlay strategies.

“Diversifying your sources of alpha simply makes sense and should give institutional clients a greater level of confidence that their portfolios will deliver stable market returns,” Wright said.

The most common way additional alpha is being sought is through the separation of the revenue streams within the fixed income allocation of a portfolio into distinct alpha, or income generated through manager skill, or beta, income from market movements, components and managing each source separately.

According to Wright, this process allows fixed income managers to develop a core element of the portfolio that deals with market returns, and complement it with a satellite module that provides alpha return via a series of diverse strategies.

He expects this type of fixed income management to become accepted practice over the next five years.

“The opportunity to add alpha in the fixed income space is significant. Just as in the equities space, Australian investors need to focus on managers who have real alpha skills,” Wright said.