This is a sponsored article from AXA Investment Managers.
While investors in Asia have a tendency to turn towards cash when markets are volatile and uncertainty abounds, the prospect of higher inflation has diminished the attractiveness of this asset class.
This presents a fresh dilemma for investors: how can the yield-hungry beat cash returns while also mitigating the risks associated with an environment of low liquidity, high volatility and rising yields?
AXA Investment Managers (AXA IM) believes that one possible solution lies in short duration bond strategies, an asset class which can be potentially very appealing in the face of rising interest rates.
A short duration bond, as the name suggests, is a bond with a short time to maturity – typically five years or less in the Asian market. Besides the diversification benefits that these strategies may bring to portfolios, they also hold a number of advantages over their longer duration counterparts.
Where short term bonds have the upper hand
Duration is among the most important considerations for fixed income investors, as a bond’s maturity profile determines its sensitivity to interest rate movements.
Corporate bonds with short maturities are less sensitive to changes in government bond yields and credit spreads than longer maturity bonds. As such, AXA IM views short duration bonds as being a potentially useful tool for managing the risks of rising yields and persistent volatility, while also avoiding the high transaction costs inherent in other strategies.
Among the biggest risks of investing in fixed income is the threat of capital erosion when yields rise. But in addition to tackling the impact of higher yields, short duration strategies may actually benefit from these conditions as they involve higher reinvestment levels as bonds mature, allowing for a closer alignment with loftier yields.
Another advantage of short duration strategies is that they strive to minimise volatility and drawdowns when compared with wider, all maturities alternatives. Additionally, with investors increasingly conscious of fees amid the low return environment, short duration active investment strategies may minimise turnover and transaction costs. With attractive liquidity profiles – characterised by regular cash flows from maturing bonds as well as coupon payments – investors may minimise performance leakage and thus potentially improve returns.
Notably, short duration bond funds can work for both those investors wanting to ‘de-risk’ their portfolios as well as those looking to ‘re-risk’.
On the one hand, investors concerned about being exposed to rising yields, pervasive volatility and a challenging liquidity environment may look to short duration solutions to take on these challenges and potentially generate better risk-adjusted returns, relative to the longer duration market.
On the other hand, short duration strategies may offer more cautious investors the prospect of cash-beating returns without having to be exposed to excessive interest rate and volatility risk.
Ultimately, while all investments carry risks, we believe that short duration bond funds are one way to make the best of the challenging market environment without succumbing to the low – and potentially diminishing – returns of cash.
AXA IM June 2017
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This is a sponsored article from AXA Investment Managers.