Stockholm (HedgeNordic) – Like many other investors with a fixed Income component in their portfolios, asset allocators and family offices are trying to get their heads around the question as to how to obtain yield in a zero, or even negative, interest rate environment. following the Brexit referendum in the UK, the dilemma appears set to remain for the foreseeable future. Is there a single solution to the situation, or how do allocators and family offices cope with the fact that previously high yielding assets are now becoming liabilities? views differ on how to address this issue. Some investors have made minor adjustments to their strategy, while others have changed their direction dramatically.
Jonas Andersson, CIO of Navare Invest, a single family office and investment company based in Stockholm, explains that the experiments being conducted by central banks at present – pouring gasoline on the fire, in Andersson’s view, causes all asset class valuations such as fixed income, equities, real estate, etc. to skyrocket to previously unheard-of levels.
“That puts everything out of order right now, and the problem is it can continue for a long time, powered by the central bank stimulus. So it’s just to face facts and adjust,” he says. Navare Invest has therefor made changes to its overall investment strategy.
“We have made both minor adjustments to the current portfolio as well as an overview on the strategy, resulting in changes in how we will invest from the longer perspective,” says Andersson.
Within the fixed income portfolio more specifically, Andersson explains Navare Invest presently has no exposure to Investment Grade. The portfolio initiated investment just recently and it hasn’t had any “old” bonds, purchased at lower levels, to enjoy during the spread tightening. At current levels Andersson views the risk/reward ratio as far too negative, even after the Brexit referendum that ensured the lowest interest levels for many years.
“We have therefore invested more into a well-diversified high yield bond portfolio,” says Andersson. “We acknowledge the fact that there is higher volatility within the high yield space, but with a thorough selection process, finding the best issuers delivering high risk/reward, we believe that we can outperform our benchmark. We have also decided to keep the fixed income allocation at neutral level compared to benchmark. We are prepared to reduce risk for other alternatives when interest rates start to hike, or the volatility in the fixed income market rises.”
The million Dollar question remains what the alternatives to fixed income exposure with similar risk/reward charecteristics are. “We are looking at strategies outside both equities and fixed income that simplify things.
We do not believe in complicating things right now,” says Andersson. “It is the strategies that have a transparent business model, with a high conviction in delivering high returns at a low volatility, that will be sought after.” But where does one find investments like that? Surely high return at low risk sounds like an impossible combination? “Not among traditional hedge fund strategies,“ Andersson suggests.
“There are way too many highly skilled portfolio managers that don’t make returns in today’s market. That in itself tells you a lot about the challenges out there. Instead, we have really been looking into alternative strategies, among alternative funds, that are highly cash flow-generating strategies, with a long proven track record and a simple model. In many cases they come with high entry barriers and are less liquid strategies. That means that we want to shift the focus from taking risk on a yield curve, a specific issuer or a market, and instead use strategies with a higher tail risk than traditional markets (that often have a built-in volatility). Such as, for example, trade finance, insurance linked securities, cat bonds, direct lending, etc. – nothing that should correlate with interest rates or equity markets.“
Andersson continues: “Many times you will end up with higher, not so diversified, counter party risks (tail risk), which you will have to diversify by investing in many different strategies with the same risk/reward profile, but in different markets.” Navare has thus mitigated the lower yield by changing focus in the investment process. Andersson affirms: “We do not want to take risks in the traditional markets any longer – at least not to the same extent as previously. We rather search for truly uncorrelated revenue streams that we can profit from. That also includes a higher activity on the Private Equity side, where the risks are much more correlated to a thorough due diligence process and skilled investment partners, rather than depending on the market for the end result. In times like this, when nothing is as it used to be, I prefer to hold the investment risk very close…”
This article was written for the HedgeNordic Special Report on Fixed Income Strategies. You can view the the full article on pages 65-67, here: https://hedgenordic.com/wp-content/uploads/2016/09/FI.pdf
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