Only one absolute return bond manager meets cash plus return

Oksana Patron

15 May 2023

Only one absolute return bond manager has met its cash plus return objective, according to Morningstar’s analysis, as of April, of a subset of cohort of unconstrained strategies, the absolute return bond strategies.

Its senior analyst, David Little, said the managers who struggled to meet their return objectives across this category presented generally a more conservative styles of strategy and were less willing to dial up risk prior to the COVID-19 pandemic when credit conditions were strong but tightening.

“As a result, these managers have not had the return buffer to compensate for 2022’s widening in credit spreads or increase in bond yields,” he said.

However, he noted, there was the view that the return objectives for absolute return bond managers were set at a very ambitious level in the lead-up to the COVID-19 pandemic.

Little commented that PM Capital Enhanced Yield fund, which as the only one showed as green in his analysis, benefited from the fact that PM Capital was an “opportunistic credit-oriented manager that had good preparedness to take advantage of valuation opportunities arising from the coronavirus pandemic”.

“With its stronger focus on credit, PM Capital was not immune from drawdowns during the early stage of the pandemic, but all did well to de-risk as the credit tide began to turn in early 2022,” Morningstar’s analyst noted.

There were other similar opportunistic enhanced credit income strategies within the unconstrained fixed income and diversified credit Morningstar Categories that also performed relatively well, such as Bentham Global Income and Yarra Enhanced Income.

“However, in our view these strategies are overall less absolute-return-oriented and are typically higher credit risk, and were therefore not included in the assessment,” he added.

Little said that from a downside risk perspective, very few absolute return bond managers had the preparedness to meaningfully short interest-rate or credit duration over time given the impact on running yield, with an exception of T. Rowe Price.

“Generally, managers have had mixed success in terms of using credit derivative overlay strategies to protect against downside risk, which can at times be a relatively blunt tool and not always closely provide a tight hedge given the limited availability of derivatives that protect against single-name credit risk.

When asked whether the absolute return bond strategies still offered value for money, Little said his analysis highlighted the impact of one of the largest bond selloffs which followed the sharp rise in inflation and bond yields in 2022.

“We did see a modest easing in this trend in the first quarter of 2023. While from a manager selection decisioning perspective, investors should give stronger weight to the forward-looking views in Morningstar’s Analyst Rating methodology, it does highlight the challenges that managers in this space have faced with respect to meeting their individual performance objectives.”

According to their product descriptions, absolute return bond managers tend to generate consistent positive returns across all market environments, including negative markets like in 2022.

Traditionally, these strategies focused on targeting downside protection, delivering cash plus returns and providing steady investment incomes.