the potential benefits of diversification in fixed income ... · andrew feltus, cfa. managing...
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Andrew Feltus, CFAManaging Director, Co-Director of High YieldPortfolio ManagerAmundi Pioneer Asset Management
The Potential Benefits of DiversificationIn Fixed Income Portfolios
Agenda
• Market Beliefs• Fixed Income Goals• Fixed Income Index Characteristics• Active Universe Characteristics• Implications• Conclusion
Key Assumptions Regarding Financial Markets per CAPM (Capital Asset Pricing Model)
Financial Markets:• The future will resemble the past• Asset class returns revert to their means over the longer term• Markets are efficient, so tactical allocation does not add value• Market capitalization fixed income indices are efficiently constructed• Fixed income indices represent the best proxy for the investable universe• Markets are liquid
Role of Fixed IncomePursue primary goals:• Income• Diversification*/hedge versus
equities• Low volatility—anchor to portfolio
Pursue secondary goals:• Deflation protection• Preserve purchasing power
(inflation hedge)• Hedge liabilities
Implementation:• Two primary options of index
versus active
Recent experience has driven investors to expect income
Potential Key Risks:• Rise in interest rates• Credit risk, default rate rises• Liquidity
Source: Bloomberg Barclays and Bureau of Labor Statistics, December 31, 2017*Diversification does not assure a profit or protect against loss.
0%
5%
10%
15%
20%
25%
1981-1985
1986-1990
1991-1995
1996-2000
2001-2005
2006-2010
2011-2015
2016-2017
Bloomberg Barclays US Aggregate Bond IndexReturn (Annualized)CPI YOY
10 Year Treasury Yield
Broad Fixed Income Index Assumptions per CAPM (Capital Asset Pricing Model)
Broad Fixed Income Indices:• Offer sufficient risk factor and sector diversification, including major liquid sectors of
Treasuries, agency mortgage-backed securities and investment grade corporates• Represent a low-risk, low-cost default option for investors• Are investable• Have a static risk profile• Underlying securities are sufficiently liquid
Broad Market Fixed Income Indices – The Reality• Broad market indices offer minimal risk diversification• Broad market fixed income index risk is not static, and has increased significantly• Market-capitalization weighting favors largest debtors, encourages bubbles and
excessive leverage and misallocates capital• Fixed income valuations are driven by non-economic motives, including central banks
or liability-driven investors• Static, rules-based investing (index or regulation-driven) creates price overshoots on
upside and downside
• Pricing:• Index investor is price–taker in a market in which prices are negotiated• An index is not investable and is matrix-priced• Indexers favor most liquid issues, foregoing liquidity premium and potentially
increasing volatility
Undiversified Risk Exposures of the US and Global Aggregate Bond Indices
Source: Barclays Point as of December 31, 2017
-20
0
20
40
60
80
100
120
140
160
CTE
V Ba
sis
Poin
ts
Bloomberg Barclays US Aggregate Bond Index
It's All Duration
-20
0
20
40
60
80
100
120
Bloomberg Barclays Global Aggregate Bond Index
It's Currency and Duration
Index Risk is not Static: Highest Duration and Near Lowest Yield in History
Bloomberg Barclays US Aggregate Bond Index: Yield-to Worst versus Effective Duration
Bloomberg Barclays Global Aggregate Bond Index: Yield-to Worst versus Effective Duration
• Yield per unit of duration has declined dramatically• Beginning yield dominant factor for future returns
Source: Barclays as of January 31, 2018
0
1
2
3
4
5
6
7
8
Inde
x
BBG Barclays US Agg DurationBBG Barclays US Agg YTW
0
1
2
3
4
5
6
7
8
Inde
x
BBG Barclays Global Agg DurationBBG Barclays Global Agg YTW
Risk in Benchmark-Driven AllocationsIncreasing and significant government exposure
Source: Barclays Point as of December 31, 2017
ABS/CMBSYankees
Investment Grade Corporate
Agency MBS
Agencies
Treasuries
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016
37.0%
28.1%
2.4%
21.5%
8.7%
2.4%
Tota
l U.S
. Gov
ernm
ent:
67%
Higher Credit Risk in Broad Market Index
AAA AA A Baa
26.1%9.1%
31.7%
10.0%
32.1%
37.1%
10.0%
43.8%
Proportion of BBB bonds has more than tripled since 1973
45%
Changes in the Quality of the Bloomberg Barclays Credit Index 1973-2017
Source: Bloomberg Barclays as of December 31, 2017
Profile:Fixed Income Market Investors• Global Central Banks
• Motivation from monetary policy, FX reserve management• Focus on Treasury/agency mortgage-backed securities market
• Insurance Companies• Risk-based capital rules drive forced selling of corporate downgrades to non-
investment grade• Corporate Pensions
• Goal to immunize pension obligations by investing in long duration corporates and Treasuries
• Corporate Offshore Cash• Tax policy has driven corporate investors to hold $1.4 trillion cash offshore• Repatriation will reduce demand for short corporates
• Profit-driven investors• Traditional asset managers
Source: Bloomberg View, The New US Tax Rules are a Gift to Europe, 1/17/18
Profile: Active US Fixed Income Investors
• Diverse risk exposures• Invest in both benchmark and non-benchmark sectors, opening opportunity set for
higher potential returns, while lower correlations dampen total volatility• Dynamic, not rules-based
• Responds to changing price of risk• Reacts to changing quantity of risk• Considers changing economic/market regimes• May benefit from mean-reversion of fixed income and rebalancing return
• Full menu of information items to determine allocations• Investor has role as price-setter
• Can invest in market with negotiated prices
Diverse Sectors Can Offer the Advantage of Lower Correlated Returns
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
1 US Treasuries 1.00
2 Agencies 0.93 1.00
3 Agency Mortgage-Backed Securities 0.8 0.86 1.00
4 Commercial Mortgage-Backed Securities -0.02 0.14 0.01 1.00
5 Investment Grade Corporates 0.43 0.58 0.53 0.48 1.00
6 Treasury Inflation-Protected Securities 0.54 0.61 0.61 0.42 0.68 1.00
7 Municipals 0.33 0.39 0.42 0.31 0.56 0.44 1.00
8 Non-Agency Asset-Backed Securities -0.38 -0.36 -0.25 0.42 0.18 0.15 0.14 1.00
9 High Yield -0.24 -0.02 0.03 0.72 0.65 0.47 0.33 0.51 1.00
10 Leveraged Bank Loans -0.45 -0.32 -0.16 0.54 0.4 0.27 0.26 0.71 0.85 1.00
11 Convertibles -0.29 -0.1 -0.05 0.57 0.54 0.34 0.23 0.43 0.87 0.75 1.00
12 Preferred Stock 0.03 0.12 0 0.51 0.52 0.29 0.3 0.16 0.51 0.29 0.53 1.00
13 International Bonds 0.49 0.59 0.49 0.3 0.53 0.56 0.28 -0.13 0.28 -0.02 0.23 0.33 1.00
14 Emerging Market Bonds 0.25 0.44 0.45 0.53 0.77 0.68 0.5 0.2 0.74 0.47 0.64 0.41 0.56 1.00
15 Event-Linked (Catastrophe) Bonds 0.06 0.07 0.06 0.18 0.22 0.16 0.18 0.23 0.22 0.27 0.21 0.09 0.09 0.18 1.00
Traditional Fixed Income Sectors
Non-Traditional Fixed Income Sectors
10-year correlations
Source: Barclays, BofA Merrill Lynch, JP Morgan, Morningstar as of 31 December 2017 Asset classes represented by the following indices: US Treasuries – Bloomberg Barclays US Treasury Index, Agencies - Bloomberg Barclays US Agency Index, Agency Mortgage-Backed Securities - Bloomberg Barclays US Agency Fixed Rate MBS Index, Commercial Mortgage-Backed Securities - Bloomberg Barclays CMBS Investment Grade Index, Investment Grade Corporates - Bloomberg Barclays US Corporate Investment Grade Index, Treasury Inflation-Protected Securities - Bloomberg Barclays US Treasury TIPS Index, Municipals - Bloomberg Barclays Municipal Index, Non-Agency Asset-Backed Securities – ICE BofAMerrill Lynch ABS Master Floating Rate Index, High Yield – ICE BofA Merrill Lynch US High Yield Index, Leveraged Bank Loans - Credit Suisse Leveraged Loan Index, Convertibles – ICE BofA Merrill Lynch All Convertible Index, Preferred Stock – ICE BofA Merrill Lynch Preferred Stock Index, International Bonds – Citi WGBI non USD Index, Emerging Markets Bonds – JPMorgan EMBI Plus Index, Event-linked (Catastrophe) Bonds – SwissRe Cat Bond Index
10 Years of Fixed Income Returns: Potential Benefits of Diverse Credit Exposures
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Non-US Corporate10.11%
US High Yield57.51%
Convertible16.77%
Municipal11.19%
UK Corporate21.1%
Convertible24.92%
Preferred13.68%
Preferred7.72%
US High Yield17.49%
Convertible16.03%
Municipal-3.95%
Convertible49.13%
US High Yield15.19%
Emerging Market Debt9.2%
Emerging Market Debt
18.04%
US High Yield7.42%
Municipal9.78%
Municipal3.3%
Convertible11.94%
UK Corporate15.11%
US Corporate-6.82%
Leveraged Loans44.87%
Preferred13.97%
US Corporate7.51%
US High Yield15.59%
Leveraged Loans6.15%
Convertible9.44%
Emerging Market Debt
1.82%
Leveraged Loans10.16%
Preferred12.03%
Preferred-8.99%
UK Corporate29.56%
Emerging Market Debt
11.83%
Non-US Corporate5.17%
Convertible14.96%
UK Corporate3.69%
US Corporate7.51%
Asset-Backed Securities
-0.54%
Emerging Market Debt
9.62%
Non-US Corporate10.33%
Emerging Market Debt-9.7%
Emerging Market Debt
25.95%
Leveraged Loans9.98%
UK Corporate5.1%
Preferred11.64%
Asset-Backed Securities
1.34%
Emerging Market Debt
6.15%
US Corporate-0.63%
US Corporate5.96%
Emerging Market Debt
8.29%Asset-Backed
Securities-24.27%
US Corporate19.76%
US Corporate9.52%
US High Yield4.38%
US Corporate10.37%
Preferred-0.94%
UK Corporate5.99%
Leveraged Loans-0.69%
Asset-Backed Securities
1.82%
US High Yield7.48%
US High Yield-26.39%
Municipal14.45%
UK Corporate5.45%
Preferred1.86%
Leveraged Loans9.43%
US Corporate-1.46%
US High Yield2.5%
Convertible-1.15%
Non-US Corporate1.81%
US Corporate6.48%
Leveraged Loans-28.75%
Preferred14.14%
Non-US Corporate5.21%
Leveraged Loans1.82%
Municipal7.26%
Municipal-2.89%
Leveraged Loans2.06%
US High Yield-4.64%
Preferred1.77%
Municipal5.45%
UK Corporate-34.34%
Asset-Backed Securities
9.09%
Asset-Backed Securities
4.8%
Asset-Backed Securities
0.55%
Asset-Backed Securities
2.95%
Non-US Corporate-4.56%
Asset-Backed Securities
1.55%
UK Corporate-4.97%
Municipal0.25%
Leveraged Loans4.12%
Convertible-35.73%
Non-US Corporate4.39%
Municipal2.25%
Convertible-5.18%
Non-US Corporate1.51%
Emerging Market Debt
-8.31%
Non-US Corporate-2.68%
Non-US Corporate-5.54%
UK Corporate-6.18%
Asset-Backed Securities
2.9%USD Returns. Performance data shown represents past performance. Past performance does not guarantee future results. Indices shown: ICE BofA Merrill Lynch Corporate Bond Master measures performance of the investment grade corporate bond market. ICE BofA Merrill Lynch Municipal Master Index, measures the performance of the overall municipal bond market. ICE BofA Merrill Lynch US High Yield measures performance of the US high yield bond market. S&P/LSTA Leveraged Loan, a commonly used benchmark for higher yielding, higher risk loans. ICE BofA Merrill Lynch US Preferred Stock Hybrid Security Index measures the fixed-rate preferred stock market. ICE BofA Merrill Lynch US Convertible Bonds Index measures the convertible bond market. Citi WGBI Non USD Index, measures the performance of Non-US investment grade bond issuance. JP Morgan EMBI Plus tracks the performance of the below- and borderline-investment-grade global debt markets denominated in the major developed currencies. Bloomberg Barclays Sterling Corporate Bond, measures the performance of the UK corporate market.Indices are unmanaged and their returns assume reinvestment of dividends and, unlike mutual fund returns, do not reflect any fees or expenses associated with a mutual fund. It is not possible to invest directly in an index. Diversification does not guarantee a profit or protect against a loss. Source: Amundi Pioneer Asset Management as at 31 December 2017
Active Risk Management:Expanded Opportunity SetThe US Core and Core Plus Universe
Government Investment Grade Credit
Mortgage-Backed Securities
Commercial Mortgage-Backed
Securities
Asset-Backed Securities Municipal Insurance-Linked
Securities
Floating-Rate Note
Treasury Inflation-Protected Securities
Sub Paper
Bank Loans
High Yield
Adjustable-Rate Mortgage
Collateralized Mortgage
Obligations
Residential Mortgage-Backed
Securities
Single-Family Residence
Floating-Rate Note
Source: Bloomberg Barclays
Overview of Structured Credit Structured
Residential Mortgage-
Backed Securities
Government
-Ginnie Mae-Federal National Mortgage
Association-Freddie Mac
Credit
-Prime-Alt-A
-Subprime-Single-Family
Residence-Nonperforming
Loan-Non-US
Asset-Backed Securities
Government
-Small Business Administration
-FNW
Credit
-Auto-Credit Card
-Student Loan-Esoteric
Commercial Mortgage-
Backed Securities
Government
-Ginnie Mae-Federal National Mortgage
Association-Freddie Mac
Credit
-Conduit-Small Balance-Unguaranteed
-Large Loan
Sources: ICE BofA Merrill Lynch and Bloomberg Barclays
Dynamic Allocation: Valuations and Fundamentals Drive Allocation Decision
0%
5%
10%
15%
20%
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
Defaults Spread
Current Option-Adjusted Spread: 329 basis points
Current Default Rate: 3.0%
Averages:Option-Adjusted Spread: 555 basis points
Default: 4.56%
US High Yield Spreads and Defaults
Sources: Moody’s, ICE BofA Merrill Lynch, Amundi Pioneer, January 31, 2018
Impact of Regime-Oriented Asset Allocation on Returns
Source: Journal of Portfolio Management, Winter 2018: Active Risk-Based Investing, Emmanuel Jurczenko and Jérôme Teiletche
Impact of Regime-Oriented Asset Allocation on Distribution of Returns
Source: JP Morgan Asset Management, Impact of Macro Shifts on Asset Class and Portfolio Performance, 2011
Dynamic Risk Allocation of Multisector; Index Remains Static
Source: Barclays Point and Amundi Pioneer, January 31, 2018
-15
35
85
135
185
235Ex-Ante Factor CTEV (bps/month) TIPS
DefaultIdiosyncraticEM/OtherAgency MBSNon-Agency SecHY/EquityVol/SS/Gov SpdOthers
Investment Grade
Curve
FX
Positioning for Rising Rate Environment• Interest rate factor positioning
• Relative short duration versus Index, barbelled yield curve and non-US sovereign exposures should help reduce exposure to rising rates in the US. Source of duration in credit versus Treasury sectors further reduces rate sensitivity
• Unconstrained duration approach may be suboptimal, because tends to increase exposure to high yield credit to offset negative carry
• Higher yield • Yield-to-maturity significantly higher than Index may help offset principal loss from
rising rates • Floating rate exposure
• Significant floating rate exposure may include bank loans, non-agency asset-backed securities, home equity loans and event-linked (catastrophe) bonds
• An underweight to most rate-sensitive assets• US government sector exposure significantly lower than Bloomberg Barclays US
Aggregate Index• An overweight to credit, particularly non-investment grade credit
• High yield has average 0.5 interest rate sensitivity, compared to US Treasuries
Will a Broad Fixed Income Index Approach Diversify Equity Risk?
Source:Bloomberg, Bloomberg Barclays, 12/31/17
-4
-2
0
2
4
6
8
10
12
14
16
-1.000
-0.800
-0.600
-0.400
-0.200
0.000
0.200
0.400
0.600
0.800
Jan-73 Jan-78 Jan-83 Jan-88 Jan-93 Jan-98 Jan-03 Jan-08 Jan-13
Correlation between Bonds and Equities vs. Inflation
Bond-Equity Correlation, 3 Years CPI Inflation
Rolling 3-year Correlations Bonds and Equities; Equities and High Yield
0
0.2
0.4
0.6
0.8
1
Dec-99 Dec-04 Dec-09 Dec-14
Rolling 3-year Correlation between HY Spreads and Equities
-1.00
-0.50
0.00
0.50
1.00
Jan-73 Jan-78 Jan-83 Jan-88 Jan-93 Jan-98 Jan-03 Jan-08 Jan-13
Rolling 3-year correlation between Bonds and Equities
Source: Bloomberg, Bloomberg Barclays and ICE BofA Merrill Lynch, 12/31/17
Implementation: Core-Satellite or Multi-Sector Manager?• Multi-sector manager
• Seek manager with proven skill in dynamic allocation• Pursue manager with deep skillset across broad range of fixed income sectors
• Core-satellite can result in inefficient, unintended risk allocation• Employ a multi-sector manager that can tailor risk for specific investor• Avoid sleeve sectors that may double up or cancel out risks
• Management and cost efficiency• Consider that fewer managers yields lower managerial oversight requirement• Explore cheaper access to satellite sectors (such as high yield, bank loans,
insurance-linked securities), with a multi-sector manager
Median Fixed Income Manager: Outperformed the Index in Rising Rate Periods; Modestly Lagged in Others
Source: Impact of Market Conditions on Bond Fund ManagersHarsh Parikhand, Frank J. Fabozzi , Winter 2018 Journal of Portfolio Management
Multi-Sector Fixed Income: Potential for Attractive Risk/Reward Profile Relative to Fixed Income Indices
Source: Amundi Pioneer Asset Management, and eVestment as of December 31, 2017 eVestment Alliance, LLC and its affiliated entities (collectively, “eVestment”) collect information directly from investment management firms and other sources believed to be reliable; however, eVestment does not guarantee or warrant the accuracy, timeliness or completeness of the information provided and is not responsible for any errors or omissions. Performance results may be provided with additional disclosures available on eVestment’s systems and other important considerations such as fees that may be applicable. All categories not necessarily included and may not equal 100%. Copyright 2012-2017 eVestment Alliance, LLC. All Rights Reserved.
10-Year Returns and Standard Deviation
Core Plus Category Average
Bloomberg Barclays 5-Year
Treasury Bellwether
Bloomberg Barclays Global Aggregate ex-USD
Bloomberg Barclays US Aggregate
Bloomberg Barclays US Corporate Investment …
Bloomberg Barclays US Mortgage-Backed
SecuritiesBloomberg Barclays US
Universal
ICE BofA Merrill Lynch BB-B US Cash Pay High Yield
Constrained
ICE BofA Merrill Lynch …
Citigroup 3-Month T-Bill
JPMorgan EMBI+
Agg 70/HY20/EM10
Agg 60/HY30/EM10
0
2
4
6
8
10
0 2 4 6 8 10 12
Important InformationAmundi Pioneer Asset Management is the US business of the Amundi Asset Management group of companies. Investment advisory services are offered through Amundi Pioneer Asset Management, Inc. and Amundi Pioneer Institutional Asset Management, Inc. (collectively “Amundi Pioneer”). Not all Amundi products and services are available in all jurisdictions.
The views expressed are those of Amundi Pioneer and are current through the date indicated on the material and are subject tochange at any time based on market or other conditions. Amundi Pioneer disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Amundi Pioneer strategies are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Amundi Pioneer strategy or portfolio. Future results may differ significantly from those stated.
This document does not constitute investment advice and does not take account of the investment objectives or needs of or suitability for a specific investor. Please seek professional advice before you invest.