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One of the most efficient ways to implement short duration bond strategies

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This is a sponsored article from AXA Investment Managers.

 

In a volatile market where investors are switching rapidly between risk-on and risk-off positions, AXA Investment Managers (AXA IM) believes that investors should consider strategic allocations into short duration bond strategies, with the asset manager preferring direct investments rather than using derivatives to artificially reduce durations.

In an environment of rising government bond yields – the US Federal Reserve is expected to lift rates at least once more this year – short duration bond strategies tend to outperform relative to the broader all-maturities credit market.

This is because short duration bonds are, by their nature, less sensitive to changes in bond yields and credit spreads. The attractive maturity profile of these strategies is associated with regular cash flows, which can be reinvested at higher yields in the market.

In addition, short duration investing offers limited volatility and drawdowns relative to the broader market – an attractive proposition in today’s uncertain investment climate.

On the other hand, as credit spreads tighten, or when government bond yields decline, short duration bond strategies typically underperform the broader credit market.

Direct approach versus derivatives
Investors use two main approaches when employing short duration bond strategies: direct investments into short-dated corporate bonds, and investments across the maturity spectrum while using derivatives to artificially decrease the duration of the portfolio.

AXA IM favours the direct investment route, partly because the derivatives approach can lead to sub-optimal returns and diminished liquidity.

The asset manager explains that as the underlying bonds of derivatives mature farther out in the future, even if the interest rate risk is reduced through derivatives, the credit spread risk may still be high – which can ultimately have a negative impact on risk-adjusted returns.

More importantly, strategies using the derivatives approach do not benefit from attractive natural liquidity profiles, as many of their underlying bonds mature much farther down the line. This implies higher transaction costs and these strategies missing out on higher yields and additional liquidity buffers.

With a number of market risks looming through the remainder of 2017 – investors will be keeping an eye on central banks’ monetary policies, Donald Trump’s policy implementation and Brexit negotiations – volatility could remain high and AXA IM says that direct investments into short duration bonds are compelling.

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This is a sponsored article from AXA Investment Managers.

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