• Fixed Income
  • Multi-Strategy Fixed Income
  • Multi-Strategy

Interesting times: the advantages of active fixed income

Opportunity knocks for fixed income investors who are not forced to ‘hug’ market indices.

baby penguins and an emperor penguin

Whether it’s cliché or understatement to say so, we live in interesting times. Political uncertainties, changing monetary policy and resilient global growth all pose significant challenges for bond investors. Yields on 10-year US Treasuries have recently risen to their highest level for four years, prompting some commentators to call the end of the 37-year bull market in bonds.

Of course, we have seen spikes in bond yields during the long bull market – as in 2004 to 2006, for example, when the Federal Reserve embarked on a modest tightening cycle. But this time, things really could be different. Why? Because duration – sensitivity to changes in interest rates – is higher than it has ever been. And that means that markets are much more susceptible to a sustained move higher in interest rates than they were during previous periods of stress.

Meanwhile, the low base from which yields are rising poses dangers of its own. The total return on a fixed income index, we should never forget, is part coupon (the interest payment) and part capital appreciation (or depreciation!). When there have been moments of stress during the long bull market, delivering negative periods of capital return, the coupon payments have acted as a cushion ensuring that total returns have on the whole been positive. Today, with yields at significantly lower levels, there is much less scope for that as more recently issued bonds have reset at the current coupon rates, reducing the previously afforded protection.

But while these interesting times pose threats, they also create opportunities – particularly for active investors who have the freedom to exploit them and who are not forced to ‘hug’ market indices that might be poised for declines.

Firstly, the indiscriminate buying that we’ve seen as yields fall is unlikely to continue when things go into reverse – especially as price-insensitive buyers such as central banks scale back their purchases. Security selection should come to the fore. Historically, credit dispersion has risen along with overall credit spreads. In other words, a less correlated market offers greater opportunities for active managers who have the process and expertise in terms of credit research to both identify opportunities as well as avoiding unfavourable situations.

The most obvious advantage of an active approach is the ability to avoid the fate of the overall market. As bond indices are based on issuance, benchmarks inevitably lead you to the most heavily indebted companies: those that have issued the most bonds. Active investors have the opportunity to position their portfolios so that they can take exposure to companies that have stronger cashflows as well as clearly defined repayment strategies, in addition there is the opportunity to disaggregate credit risk from that of interest rate risk, focusing on shorter  duration bonds than the broader market.

At a time when passive approaches are increasingly dominant in the equity markets, it’s worth noting that fixed income markets are very different from equities.  Their upside is potentially capped, so it’s the downside – the risk of default – that you really have to worry about. And that is where active credit analysis can offer a real advantage.

Yet another consideration is the huge amount of variation within the bond market. Even the same company’s issues typically offer differing maturities and differing levels within the capital structure (either senior unsecured through to subordinate and contingent capital issues). An active investor carrying out in-depth analysis of these issues, would look to focus on maximising the risk adjusted return of their decisions and not own all the companies issues indiscriminately as would be the case within an index.

Liquidity is important too.  Increased regulation has challenged liquidity at a time when banks are less inclined to act as market-makers than they were in the past. It is therefore imperative to consider the dynamics of both entering and exiting positions when considering the overall return dynamics of each active investment decision.  Execution strategies continue to play an important role in the overall process.

So, as an unprecedented period of central-bank policy comes to an end, these are indeed interesting times for the bond markets. According to contemporary folklore, ‘May you live in interesting times’ is an ancient Chinese curse. But for skilled active investors, a market characterised by greater uncertainty and higher dispersions will provide the opportunities to deliver on the expected outcomes.

Related views

Important information


Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (AIGSL). Unless stated otherwise any views and opinions are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Information contained herein has been obtained from sources believed to be reliable, but has not been independently verified by Aviva Investors and is not guaranteed to be accurate. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Nothing in this material, including any references to specific securities, assets classes and financial markets is intended to or should be construed as advice or recommendations of any nature. Some data shown are hypothetical or projected and may not come to pass as stated due to changes in market conditions and are not guarantees of future outcomes. This material is not a recommendation to sell or purchase any investment.

The information contained herein is for general guidance only. It is the responsibility of any person or persons in possession of this information to inform themselves of, and to observe, all applicable laws and regulations of any relevant jurisdiction. The information contained herein does not constitute an offer or solicitation to any person in any jurisdiction in which such offer or solicitation is not authorised or to any person to whom it would be unlawful to make such offer or solicitation.

In Europe, this document is issued by Aviva Investors Luxembourg S.A. Registered Office: 2 rue du Fort Bourbon, 1st Floor, 1249 Luxembourg. Supervised by Commission de Surveillance du Secteur Financier. An Aviva company. In the UK, this document is by Aviva Investors Global Services Limited. Registered in England No. 1151805. Registered Office: 80 Fenchurch Street, London, EC3M 4AE. Authorised and regulated by the Financial Conduct Authority. Firm Reference No. 119178. In Switzerland, this document is issued by Aviva Investors Schweiz GmbH.

In Singapore, this material is being circulated by way of an arrangement with Aviva Investors Asia Pte. Limited (AIAPL) for distribution to institutional investors only. Please note that AIAPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIAPL in respect of any matters arising from, or in connection with, this material. AIAPL, a company incorporated under the laws of Singapore with registration number 200813519W, holds a valid Capital Markets Services Licence to carry out fund management activities issued under the Securities and Futures Act (Singapore Statute Cap. 289) and Asian Exempt Financial Adviser for the purposes of the Financial Advisers Act (Singapore Statute Cap.110). Registered Office: 138 Market Street, #05-01 CapitaGreen, Singapore 048946.

In Australia, this material is being circulated by way of an arrangement with Aviva Investors Pacific Pty Ltd (AIPPL) for distribution to wholesale investors only. Please note that AIPPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIPPL in respect of any matters arising from, or in connection with, this material. AIPPL, a company incorporated under the laws of Australia with Australian Business No. 87 153 200 278 and Australian Company No. 153 200 278, holds an Australian Financial Services License (AFSL 411458) issued by the Australian Securities and Investments Commission. Business address: Level 27, 101 Collins Street, Melbourne, VIC 3000, Australia.

The name “Aviva Investors” as used in this material refers to the global organization of affiliated asset management businesses operating under the Aviva Investors name. Each Aviva investors’ affiliate is a subsidiary of Aviva plc, a publicly- traded multi-national financial services company headquartered in the United Kingdom.

Aviva Investors Canada, Inc. (“AIC”) is located in Toronto and is based within the North American region of the global organization of affiliated asset management businesses operating under the Aviva Investors name. AIC is registered with the Ontario Securities Commission as a commodity trading manager, exempt market dealer, portfolio manager and investment fund manager. AIC is also registered as an exempt market dealer and portfolio manager in each province of Canada and may also be registered as an investment fund manager in certain other applicable provinces.

Aviva Investors Americas LLC is a federally registered investment advisor with the U.S. Securities and Exchange Commission. Aviva Investors Americas is also a commodity trading advisor (“CTA”) registered with the Commodity Futures Trading Commission (“CFTC”) and is a member of the National Futures Association (“NFA”). AIA’s Form ADV Part 2A, which provides background information about the firm and its business practices, is available upon written request to: Compliance Department, 225 West Wacker Drive, Suite 2250, Chicago, IL 60606.