FAs Concerned They Should Diversify Bond Allocations
Source: FA-IQ @ Schwab Impact 2016, Dec. 8, 2016
BRUCE LOVE, MANAGING EDITOR, FINANCIAL ADVISOR IQ: Hi, this is Bruce Love with Financial Advisor IQ. And I’m here with Raman Srivastava, global head of fixed income at Standish. Raman, what are you seeing in advisors’ portfolios in terms of fixed income these days?
RAMAN SRIVASTAVA, GLOBAL HEAD OF FIXED INCOME, STANDISH: I think advisors are largely looking to diversify their current fixed income holdings. There’s concern around how their fixed income holdings domestically would hold up in an environment where the Fed is potentially hiking rates, or if we’re transitioning to a higher rate environment. A lot of advisors have tended to do this via credit. More and more of them are realizing that credit tends to be highly correlated to stocks.
So one of the things that we’re having a lot of discussions about is global fixed income — diversifying your domestic high-quality fixed income into international fixed income to provide that diversity. Importantly, many advisors have done this historically via currency. But we think the better approach is actually to hedge the currency risk back to the dollar, much less volatile, looks and feels a lot more like domestic fixed income.
BRUCE LOVE: Why do you think that is?
RAMAN SRIVASTAVA: Currency, while it can provide some opportunities, it introduces a tremendous amount of volatility into the portfolio. It could be two or three times the amount of volatility that you would typically get from fixed income.
Most advisors that we speak to use fixed income as the ballast in their portfolio. They’re not looking for it to provide a lot of volatility within their asset allocation. They want it to be the ballast. So by hedging the currency, you reduce the risk, you make it more act like a ballast, as opposed to something with a lot more volatility.
BRUCE LOVE: With that sort of pivot in assets, is it hard to find instruments to use?
RAMAN SRIVASTAVA: It’s more challenging these days to find instruments that provide attractive return opportunities in global fixed income. The nice thing is, increasingly, a growing share of the issuance is coming from outside of the U.S. At this stage of the game, roughly 60% of the issuance is actually outside of the U.S.
So if you open up your opportunity set, you can find these pockets of opportunities. We’ve found pockets of opportunities over the years in Eastern Europe, in Moroccan bonds, in less-followed areas of the global fixed income markets. Again, keeping that high-quality component, but being able to diversify away from just U.S. rates.
BRUCE LOVE: Are there more considerations there, like tax or transaction?
RAMAN SRIVASTAVA: In the developed markets, it’s a fairly liquid market. The minute you start straying into some of the emerging markets, you do have to think about liquidity. You have to think about transaction costs or other structural costs to get in and out of the markets.
We tend to be fairly active with the portfolio. We primarily use developed market exposure. We think that works best for advisors looking for, again, high-quality fixed income.
But to be sure, there are opportunities in emerging markets. There are a lot of opportunities, actually, in between. A lot of countries lie sort of in between the developed markets and emerging markets, less followed. We find plenty of opportunities in those.
BRUCE LOVE: If you’re an advisor, though, how do you get your research done to make sure that you’re finding the right market there?
RAMAN SRIVASTAVA: Well, this is where I think active management comes in quite handy. We have a team of over 130 people, investment professionals scattered throughout the globe looking at these opportunities as part of what we provide as a value-add to advisors — give us the responsibility of researching these markets, understanding the risks, putting them together thoughtfully in a portfolio. That is our job. And the advisors can best choose how it fits within their individual portfolio construction.
BRUCE LOVE: Do you think in the fixed income world these are going to be moves that they are going to have to redo yet again in a shorter time horizon? I mean, will they need to be looking at this more and more in the future?
RAMAN SRIVASTAVA: Well, I think there’s a structural component. There are two structural reasons why you would consider diversifying. One is a broader opportunity set, again, as more and more issuance is coming outside of the U.S. The second is the basic tenet of diversification. Why have all of your fixed income exposure exposed to one interest rate market when you can diversify it across many high-quality ones.
The more compelling reason right now is actually the cyclical reason. If you look at what the Federal Reserve here in the U.S. is about to do in terms of slowly hiking rates, they are still tightening. It’s a stark contrast to what’s happening in a lot of other global developed markets where central banks are still faced with more easing, more rate cutting, much more support for those fixed income markets versus the one here at home.
So I think cyclically, the impetus is there. But I think structurally, it makes a lot of sense. And most advisors that we speak to are under-allocated to non-domestic fixed income. They may have increased international equities, but have yet to do so on the fixed income side.
BRUCE LOVE: But do you need to be a central bank watcher to find these little gems? I mean, what’s going on out there at the moment?
RAMAN SRIVASTAVA: You’ve got to watch central banks, you got to watch politics, which is increasingly important. A lot of these countries and economies, you obviously have to watch the economic data. It’s quite a lot.
There are over 15,000 securities in the global fixed income market. So it does require quite a bit of work, quite a bit of scouring. There’s certainly a macro component to it. We spent a lot of time on macroeconomic analysis, a lot of time looking at the political risks. But you can’t ignore the more traditional tenets of fixed income investing as well.
BRUCE LOVE: Raman, thank you very much.
RAMAN SRIVASTAVA: Thanks, Bruce.