6 mins read
Nick Maroutsos, Dan Siluk and Jason England, managers of the Janus Henderson Absolute Return Income strategy, discuss the relationship between yield curves and duration, their approach to volatility, and how absolute return income can complement conventional fixed income approaches
Meeting the needs of risk-averse clients
3 mins read
Nick Maroutsos, Co-Head of Global Bonds at Janus Henderson, explains what he sees as the major factors influencing investors’ decisions in 2019
A changing fixed income world: challenges in 2019
5 mins read
After a three-decade long bull market in bonds, investors are now facing a conundrum when it comes to investing in an asset class which has been considered a safe-haven for so long. Report by Investment Week
Why absolute return fixed income?
BACK TO TOP
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ver the past 30 years, investors have been able to enjoy positive returns from bonds, in part thanks to successful monetary policies that have kept inflation contained in the major markets. But with central banks gradually removing loose monetary
policy, the tailwind to traditional fixed income investing is fading. There are alternatives to traditional bond funds and investors worried about higher interest rates should consider them. They might not possess the glamour of stocks, but bonds are pretty much essential for most investors. The Janus Henderson Absolute Return Income strategy is a complement to conventional fixed income approaches. It aims to provide positive returns above those earned on cash-equivalent instruments. There is an emphasis on low volatility and capital preservation across various market conditions. In this Spotlight guide we speak with the fund’s co-managers and review how the investment team seek out value across sectors and geographies, identifying strategies priced for the best return potential in the current market environment.
Not quite. But as the bond bull market fades, a new strategy is required. We review how absolute return fixed income is in many ways a complement to conventional approaches
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The end of traditional fixed income investing?
The Janus Henderson Absolute Return Income Fund is a globally diversified fixed income fund that is designed to provide a steady income stream, while offering low volatility and stability of capital across economic cycles.
Janus Henderson Absolute Return Income
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We focus on names that are looking to de-lever in the marketplace
We believe that the Fed is done with their hiking campaign and will move to a more balanced approach, which will encourage us to increase our level of duration in 2019.
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here are three main factors we’re looking at this year. The first being the Federal Reserve. By hiking interest rates over the last few years the Fed has dictated monetary policy globally. We expect numerous central banks to follow suit but due to the
aggressive nature of the hikes in the US we think the other central banks will be more conservative in terms of how they go about any monetary tightening. The second factor is the level of rates. What we observed in 2018, particularly as it pertains to the US, were two occasions in Q1 and Q4 where interest rates shot up aggressively. The first one was as a result of misguided inflation fears. The second as a result of hawkish miscommunication from the Fed. So, the communication coming out of the central banks is critical because we believe they do not want to administer overly high rates that choke off the potential for economic growth.
other risks. In relation to the core assets we’re looking for unique names in the credit, mortgage and government space Then within the alpha component we’re looking to hedge out interest rate risk and hedge out credit risk in periods of time that we see stress. When it comes to certain central banks that may be hiking rates, we will look to hedge our interest rate risk. Whereas, where there are central banks that are on hold, we may increase the level of interest rate risk to capture exposure to attractive yields.
The last major component that we think a lot of investors will be focussing on in 2019 is liquidity. It has garnered a lot of attention over the past few years. Global fixed income markets have changed their complexion because there’s not as much issuance out there, banks are not holding as much debt on their balance sheet, and the bid/offer spreads are wider in terms of how these assets are traded. These factors mean liquidity will become a premium for much of this year. Our absolute return income strategy was established to be nimble in the marketplace because we seek to opportunistically target unique returns throughout the fixed income markets. The US is no different. Historically we’ve been moderately long US duration but we reduced that duration after Trump’s election, specifically because the Fed was looking to normalise interest rates.
Liquidity
An important element in our approach is that we aim to keep volatility low through two major components. One is through the core assets that we manage but also through the structural alpha component which looks to mitigate interest rate and
Volatility
THE HISTORY OF KAPSTREAM
exposure were the obvious choice for asset holders. But with central banks gradually removing loose monetary policy, the tailwind to traditional fixed income investing is fading. Edward Park, deputy chief investment officer at Brooks Macdonald, said: “Corporate debt has been a strong beneficiary of the post financial crisis backdrop of low interest rates and moderate economic growth; however, the tide is slowly beginning to turn. Global services and manufacturing surveys are suggesting that growth rates may have peaked in the US and Europe, implying a more challenging environment for corporates. “At the same time, whilst further aggressive monetary tightening seems unlikely from the US Federal Reserve in the short term, central banks globally are less supportive than they were. When combined with poorer liquidity in some areas of the fixed income market, the investment case for traditional fixed income is less attractive than it was.”
ver the past 30 years, investors have been able to enjoy positive returns from bonds, in part thanks to successful monetary policies that have kept inflation contained in the major markets. Declining interest rates have meant funds with long duration
Absolute return has a low correlation to traditional equity and bond markets and is therefore useful as a diversifier
However, investors also can’t afford to increase equity allocations, with stock markets facing problems of their own and higher equity allocations raising the risk profile of a balanced portfolio. Global equity markets in 2018 suffered under the pressure of trade wars, Brexit negotiations and political tension in the Eurozone. In the UK, the FTSE 100 price index suffered the worst year in a decade, falling 12.5% in sterling terms. As a result, investors are increasingly looking for an alternative; something that emphasises the diversification and safe-haven benefits traditionally attributed to bond investing; it may be time to look at absolute return fixed income as an alternative or complimentary exposure.
Charles Younes, research manager at FE, said: “2018 was a very interesting year for long-only bond managers as most of the bond markets returned negative performance. Only German Bunds and Japanese government bonds ended in positive territory, while Gilts were broadly neutral. “Therefore, there was nowhere to hide, even for strategic bond managers who benefit from greater flexibility, as they can bet on asset allocation. Unsurprisingly this sector averaged a negative performance of -2.49% last year.”
In this environment, traditional bond managers face greater challenges in delivering returns. Over the course of 2018, many traditional fixed income strategies struggled to eke out a positive performance as nearly every part of the asset class suffered declines.
Difficult year
Absolute return can offer better protection than that offered by traditional bond investment strategies, since this investment approach is not subject to the same constraints as traditional bond funds. Absolute return vehicles are not constrained by a benchmark, can take short as well as long positions depending on the manager’s view of the market through the use of derivatives, and have an emphasis on delivering positive returns with a lower volatility than the market. “Absolute return fixed income funds tend to be less volatile than long only funds (such as Strategic bond, Corporates or Gilts funds) as
How can absolute return help protect investors in a downturn?
“Absolute return fixed income managers don’t only rely on the positive direction of bond markets,” says Younes. “As an example, they could position their portfolio with a negative duration (short interest rates), or short credit (benefiting from widening credit spreads), so they could also make money when bond markets sell off.” Additionally, absolute return has a low correlation historically to traditional equity and bond markets and is therefore useful as a diversifier, especially since the correlation between equities and bonds has increased in recent years. The Janus Henderson Absolute Return Income strategy achieves this through casting a wide net by implementing a global unconstrained approach, informed by a combination of a macro top-down framework and country specific assessment for each region. But since an absolute return strategy may hedge out some of the exposure to market beta while delivering alpha through active security selection, investors must be prepared to give up some of the gains when markets are rising; the true benefits of absolute return vehicles emerge when markets are volatile or falling. Buyers must also be aware that absolute return fixed income funds still carry a degree of risk relative to keeping the money in cash.
Source: Janus Henderson Investors, as at 30 September 2018.
GROWTH OF ABSOLUTE RETURN INCOME AUM THROUGH TIME
Source: Janus Henderson Investors.
WHY INVEST IN ABSOLUTE RETURN FIXED INCOME STRATEGIES?
Diversification Access to a wider range of return sources and risk management focus means returns can be less dependent on the overall direction of markets
Lower interest rate risk The ability to go long or short duration to mitigate interest rate risk
Emphasis on positive returns Free from benchmark constraints, the focus in on positive risk-adjusted returns over cash across various market cycles
Park said: “The current economic and political uncertainties mean that philosophically absolute return mandates are highly attractive, however the challenge remains in choosing the right manager to navigate the current backdrop.”
they try to achieve a positive performance, but without requiring positive directionality from bond markets,” explains Younes. Absolute return can offer better protection than that offered by traditional bond investment strategies, since this investment approach is not subject to the same constraints as traditional bond funds. Absolute return vehicles are not constrained by a benchmark, can take short as well as long positions depending on the manager’s view of the market through the use of derivatives, and have an emphasis on delivering positive returns with a lower volatility than the market. “Absolute return fixed income funds tend to be less volatile than long only funds (such as Strategic bond, Corporates or Gilts funds) as they try to achieve a positive performance, but without requiring positive directionality from bond markets,” explains Younes. The Janus Henderson Absolute Return Income strategy has a volatility target of less than 1.5% per annum, reflective of the managers’ capital preservation mindset. The strategy aims for positive returns above those earned on cash-equivalent instruments, across various market conditions. Absolute return funds look to achieve this by using derivatives to implement defensive positioning, meaning they do not rely solely on positive direction in bond markets and have the potential to make positive returns even if markets are going down. They can take long and short duration positions to mitigate interest rate risk and are able to de-risk into cash or defensive securities during market stress. This allows absolute return bond funds to manage downside risk more effectively and makes them a useful tool in the current rising interest rate environment.
Nick: Our view is that the fixed income landscape has changed significantly in the sense that people are now looking for ways to generate returns in an environment where returns are becoming harder to come by because yields are low and credit spreads are tight. So your fixed income book is really having to work a lot harder than it has previously and managers are required to be a lot more innovative in terms of how they generate the returns. We believe that a shift to alpha is preferred over allocating purely to core fixed income because we can identify unique opportunities and we can avoid any biases related to benchmarks, be it issuers or countries. If you look at the Bloomberg Barclays Global Aggregate Index, or the US Aggregate, and then plot the yield against the duration, you’ll see there’s quite a big disparity with the duration increasing, whereas the yield decreases. So investors are actually taking on a lot more risk in their fixed income portfolios than they intended to. This makes the case for a more nimble and innovative approach to fixed income; an approach that looks to limit the duration risk but also capture the yield characteristics that fixed income provides.
You’ve talked about redefining what core fixed income allocations should look like going forward. What do you mean by that?
Jason: We were in the dovish camp going through the third and fourth quarter of 2018. We’ve always believed that the US Federal Reserve (Fed) overpromises and under delivers so after the pivot in January, we’re expecting zero hikes this year. We take the pivot to mean they are now going to be patient and flexible going forward; it’s going to take a lot for them to move because of the data. Inflation is pretty much contained at or near their 2% target so unless we see something in jobs and inflation, and we see reduced risk in the global geopolitical context, we’re more in the dovish camp.
What rate decisions do you expect to see from the Fed this year?
Dan: One of the great benefits of absolute return is we’re not mandated to hold asset classes or debt in a particular country. We have the ability to really go where we believe the best value is and avoid the areas that we think are most troubled. And that’s the case with Europe. The yield profile is significantly lower and there’s a lot of volatility around political situations like you mentioned: Brexit, the European elections, Draghi and the Central Bank. From our perspective we prefer to step back and underweight this region based on our desire to maintain a specific volatility in the portfolio, but also a reasonable return.
How are you positioning your portfolios ahead of Brexit, the European elections and political uncertainty in Germany?
INTRODUCING THE TEAM
Nick Maroutsos, Portfolio Manager Based at Newport Beach, California • Co-Head of Global Bonds at Janus Henderson and a co-founder and managing director of Kapstream Capital • Holds a BA in Economics from the University of California at San Diego, and an MBA from the UCLA Anderson School of Management • 20 years of industry experience
Jason: We have five pillars that are core to the strategy. The most important would be capital preservation. We want to preserve capital for our clients. We know a lot of them use this strategy as a short duration strategy in their fixed income portfolio so they don’t want to take capital losses. The next one would be income generation. We want to provide a steady yield for them so they can have a regular income stream. The next one is low volatility. We aim to have a volatility target of 1-1.5%, but we are actually consistently below that. We would rather underperform on our return target than put the volatility target up and push more risk into the portfolio. Then the next one is diversity and low correlation. We’re benchmark agnostic. We go looking for the best risk-adjusted returns across the globe. We offer global diversity as well as low correlation to the major indices, whether that’s equity indices like the S&P, whether it’s the high-yield indices or the global aggregate; historically, we’ve been anything between 0.3-0 correlated to those. So we can potentially add an important layer of diversity to the portfolio. Then finally: liquidity. We run a short duration, high quality portfolio that allows clients to tap into the liquidity when necessary.
What is the JHI Absolute Return Income strategy designed to do?
The strategy draws on the absolute return income specialists based in the US and Australia, and the broader Janus Henderson fixed income platform covering global bonds and global credit research. First launched in 2007, strategy assets had grown to US$9.3 billion by 31 December 2018
Daniel Siluk, Portfolio Manager Based at Sydney, Australia • A managing director of Kapstream Capital • Holds a Bachelor of Applied Finance from Macquarie University • 16 years of industry experience
Jason England, Portfolio Manager Based at Newport Beach, California • Joined Janus Henderson in 2017 • Holds a BA in business administration and finance and an MBA from the University of Southern California, Marshall School of Business • 24 years of industry experience
Nick: So as Jason alluded to, our view is that we would rather miss our return target in order to maintain our volatility target. I think many of our competitors in the space have lost sight of their initial mandate, and that is to maintain the core characteristics that Jason talked about previously. More often than not, we see managers reach for yield while moving down the capital structure into lower rated assets and emerging markets, or extending up the curve and taking on more risk. This just adds volatility to the portfolio and boosts the correlation to risk assets. We operate differently. We’re very, very fixated on maintaining low volatility because that’s what our clients expect and that’s why they’ve been invested with us for the past eleven years. So our volatility profile is one of the things we’re most proud of. Since inception of the strategy in June 2007 to end December 2018, if you look at our annualised volatility, in each of the last eleven years since we’ve been managing the strategy, its sub 1%, about 90 basis points. We can’t promise it will always be like that but we have demonstrated we can weather stress situations, be they the financial crisis or the European crises, yet still provide the safety that investors ultimately want.
What is your approach to volatility in the absolute return context?
Jason: With a lot of the indexed products you may not be getting an attractive risk/return profile given the yield and duration risk. We can get close to or near the yield, but with a lot less duration risk because we’re not managing to an index. We don’t need to go in and populate our portfolio with what’s in an index. We don’t need to be US-centric or Europe-centric. We can be a truly global, fixed income absolute return portfolio that doesn’t adhere to the biases required when managing towards an index. So I think absolute return income should be part of an investor’s toolkit. We’ve seen it here in the US as rates have started to move up; the demand is there for people to step into an asset that’s maybe a complement to their core book, where they’re not taking as much duration risk but they can still get an attractive yield.
In a market short on diversity and returns does the absolute return sector now have more appeal?
Dan: We tend to take a shorter view on the market and look at the next six to 12 months because we’re tasked with generating positive returns over that time period. From our perspective the front end of the US is extremely attractive, given the shape of the yield curve not needing to extend, but also the fact that front-end rates have moved up such a significant amount and they now offer some very good value globally. The second component would be our global allocation. We have anywhere from 12 to 14 countries represented in our asset allocation. This is typically hedged back to the base currency and this helps our diversification. Our view is that different economies operate in different economic cycles so it makes sense to allocate to the regions where we see the best opportunities. Right now these include the US, certain sectors in Australia and New Zealand, and also Asia ex Japan.
Where are you seeing the best opportunities for yield collection?
Source: Janus Henderson Investors, as at 31 December 2018. Barclays Global Aggregate Index. Monthly data.
MISMATCH BETWEEN RISK AND RETURN
Barclays Global Aggregate Index, yield to worst vs duration
Yield to worst
Duration
THE JANUS HENDERSON ABSOLUTE RETURN MINDSET: FOUR PILLARS
Capital preservation is not guaranteed.
The Janus Henderson Absolute Return Income Fund is a globally diversified fixed income fund that is designed to provide a steady income stream, while offering low volatility and stability of capital across economic cycles. The investment team seek out value across sectors and geographies, identifying strategies priced for the best return potential in the current market environment. That means the managers can take advantage of unique opportunities within countries and sectors that are often overlooked or under-represented in market indices
SECTOR ALLOCATION
Source: Janus Henderson Investors, as at 31 December 2018.
Source: Janus Henderson Investors, 4 May 2016 to 31 December 2018, Janus Henderson Absolute Return Income Fund – class A USD Acc, in USD terms.
Past performance is not a guide to future performance. All performance data includes both income and capital gains or losses and reflects the deduction of any ongoing charges or other fund expenses.
ONE
TWO
THREE
FOUR
Focus on capital preservation • Conservative risk approach with low volatility target < 1.5% p.a. • Use of derivatives to implement defensive positioning and manage downside risk
FUND IN BRIEF
FIVE
Income generation • Focus on generating a steady income stream through investing in shorter maturity investment grade securities
Uncorrelated sources of return • Wider investment opportunity set ensures returns are globally diversified • Low correlation historically to traditional equity and fixed income assets
Established track record • Solid 10+ year track record since 2007, with experience managing the strategy through periods of extreme stress and volatility • $9.3 billion strategy globally (as at 31 December 2018)
Liquidity aware • Transparent portfolio with daily liquidity and flexibility to de-risk into cash/defensive securities during times of crisis
Source: Janus Henderson Investors
Positive returns, preservation of capital and low volatility are not guaranteed. Using derivatives may involve a higher level of risk.
PERFORMANCE
INVESTMENT APPROACH
• Guided by secular outlook
• Seeking alpha generation through exploiting structural mispricing
• Cyclical overlay
• Bottom-up security analysis
TOP-DOWN AND BOTTOM-UP
YIELD FOUNDATION
STRUCTURAL ALPHA
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