Why fixed income must be viewed from total-return perspective

CEO explains how its fund rotated through the year and what he expects from the rest of 2020

Why fixed income must be viewed from total-return perspective

Investors should be looking at fixed income from a total-return perspective rather than a yield perspective, according to one CEO.

Paul Sandhu, president of Marret Asset Management, said the focus – especially in the media – is on bond yields and the central banks taking interest rates down to near zero. The conclusion among many is overwhelmingly that there is only downside.

Marret’s 18-month view of 10-year treasuries – which is trading at around seven basis points right now – is that they are going to 0.25. Sandhu said that, with yields obviously low, investors are taking outsized risks and going up the risk curve to buy high-yield investment grade bonds and lever them up.

He said: “Our view is you shouldn't be looking at fixed income from the yield perspective, you should be looking at fixed income from a total-return perspective.

“Where do you generate capital gains, not just sitting on sitting on yield and trying to leverage it up because obviously the risk-reward amount is actually not that great when yields are low. The idea is to identify which parts of fixed income are attractive within the context of how the economy is evolving and how the cycle is evolving. And that's exactly what we've done.”

The CEO stressed that fixed income is not a static asset class and that it has various components where you can derive return. He urged investors to look for a fund that is more constrained and has the flexibility to go to different areas of the asset class.

Marret was formed in 2020 and has been running alternative strategies for private clients and institutional clients since then. Its focus is fixed income and hedging interest rate and credit risk. Crucially, it’s a firm that is focused on total return and argues that, despite low rates, if you have the right element of fixed income, and the right flexible manager, clients can prosper from the asset class.

Sandhu’s long-term view is that we have entered three to seven years of low yields, low growth and low inflation because of major headwinds to global growth - high levels of leverage, weak population growth, and low productivity.

He said: “There are opportunities in fixed income, but it's a matter of recognizing where we are in the economic cycle, the credit cycle and interest-rate cycle. It’s also a matter of understanding where valuations are in any different part of fixed income as an asset class, and rotating and positioning the fund in the ones we believe will produce the highest risk adjusted return over that period. This year is a perfect example of that flexibility.”

Marret’s Absolute Return Bond Fund started the year almost totally in government bonds, with the thesis that corporate leverage was near its all-time high, credit spreads and investment grade and high yield were near all-time lows, and the risk reward in was poor.

As the year evolved, the fund rotated away from government bonds, taking advantage of central banks moving rates to zero, which generated good alpha. Sandhu said they then had the ability to pivot into credit risk when it had a significant drawdown in March and April.

He said: “That government bond positioning evolved into largely treasuries, because that's typically the safe-haven asset class. We were able to take advantage of being positioned in treasuries, which rallied quite materially, both on the back of the safe-haven trade as well as the Fed moving to cut rates to essentially zero, and then we've now repositioned over into credit, and we've taken a reasonable amount of risk, both in industrial grade and high yield credit.”

He added: “The first part of the year was about the duration trade, the second part was about the credit trade and we think the latter part of this year is going to be about the volatility trade.”

Now he believes there is dislocation between the economy and where markets are in terms of valuations. He thinks economic data globally is still beginning to slow down and that fiscal policy might become a little bit more vulnerable.

He explained that high levels of unemployment and lower levels of industrial capacity relative to the beginning of the year means that output gap is going to take many years to actually close. Marret believes those fundamental vulnerabilities, along with uncertainty over a vaccine, global trade, high levels of government debt, the U.S. election, and Brexit means more volatility is on its way.

He said: “Having taken advantage of the government trade to generate alpha and then to get into the corporate trade, to generate alpha in the second half of the year, we’ve essentially positioned the fund with a lot of cash in order to take advantage of volatility both in risk assets and government bond yields going into the end of 2020.”

He added: “You have to be in mandates that are flexible, that have the ability to rotate to different parts of fixed income where we think will deliver the best returns, total returns and risk adjusted returns over a period of time. That might be short term, as it has been this year, or over the longer term.”

Paul Sandhu was talking at the WP Advisor Connect series on alternative investing. Our next event in the series is titled Helping Advisors Understand ESG Investing and will take place on October 20. For details about the agenda and how you can register for free, click here.