22 May 2017
Dean Stewart, Executive director - Fixed Income and Currency and Matt Mulcahy, Associate Director – Senior portfolio manager - Fixed Income and Currency
Australian fixed income managers have often shown a good ability to add value in small amounts, but very poor consistency when targeting the types of excess returns expected from core and core plus strategies. This paper examines the evidence and reasons for this, and offers better alternatives for investors seeking core style excess returns. Several examples are given of strategies that deliver arbitrage or near arbitrage return opportunities.
Our findings indicate that the most common approach for core fixed income managers to achieve higher target returns in core and core plus strategies is to scale up existing strategies. However, this tends lead to an undesirable outcome as taking larger positions in more volatile strategies (such as duration trading) increases the volatility of returns – and can destroy the alpha already achieved.
However, through the incorporation of a large number of diverse, low-risk alpha strategies, it is possible to increase alpha without compromising consistency of returns. By adding many high information ratio strategies including, among others, futures arbitrage, covered interest parity and directional duration trading, we demonstrate the potential to manage core and core plus strategies using a much better approach.