Low volatility absolute return: facing the challenge of a negative-yield world
In a world of the ongoing financial repression, dominated by zero yields on cash and negative yields on more and more sovereign bonds, investors continue to grapple with the challenge of finding positive-yielding, low-risk solutions.
For clients unwilling to move further up the risk curve, we believe that an attractive way to diversify non-yielding cash is to invest in low-volatility, positive-yielding alternative investments.
We propose three classes of low-volatility, positive-yielding investment solutions:
1. Alternative UCITS funds with a focus on Global Macro, Long/Short Equity, Event-Driven and Relative Value strategies
2. Absolute return bond funds
3. Structured products
Lockdowns have driven savings
Households’ cash savings have exploded around the globe as a direct consequence of people being restricted from spending on discretionary consumer goods, travel, non-essential goods and entertainment outside the home. German households already held over 40% of their total financial assets in cash deposits prior to the 2020 lockdowns. At the time of writing, the value of negative-yielding debt worldwide has risen to a record of more than USD 17 trillion, according to the Bloomberg Barclays bond indices, and this figure has risen sharply in recent months. Investors are thus faced with a more pressing issue today: knowing how to redeploy cash to generate a positive return, while maintaining a low risk profile.
With traditional cash and bond investments no longer offering any yield to investors, we look to alternative sources for lower-risk returns in the medium term, including:
1. Alternative UCITs strategies, which can be classified into four main groups: i) Long/Short Equity; ii) Relative Value; (iii) Event-Driven; and iv) Global Macro. A number of alternative UCITs funds are managed with a level of risk in line with bond funds and often have a low correlation with general market trends. We see opportunities in these four strategies:
- Long/Short Equity: the current context of disruptive innovation and structural changes, amplified by the
Covid-19 crisis (working from home, e-commerce, dematerialisation, deglobalisation) suggests a Schumpeterian environment of ‘creative destruction’ and thus a world of polarised winners and losers. Being ‘long’ or ‘short’ on an investment helps to limit the portfolio's sensitivity to a general fall in equity markets, or to a rise in interest rates, thus limiting the risks.
- Relative Value: managers focus on mispricing assets, anomalies in spreads (yield differences) as well as a mean-reversion of prices. The crisis will eventually create clear winners and losers, even if most companies have been able to issue bonds to meet short-term financing needs. Convertible bond arbitrage is in a sweet spot, with record issuance post crisis and high single-stock volatility.
- Event-Driven: these strategies take hedged positions on Merger & Acquisition targets to benefit from the difference between the market and offer prices. Disruption, US tax reforms and sector consolidation themes provide many opportunities. Capital market activity (IPOs, secondary issues, etc.) also offer profitable opportunities to those managers. Distressed debt is another promising avenue for Event-Driven funds at present.
- Global Macro: managers benefit from large movements in the price and volatility of broad macro markets, including currencies, interest rates, equity indices and commodities. They can protect a portfolio in a severe economic downturn.
2.Absolute return bond funds
These funds use a flexible strategy mainly investing in short-maturity fixed-income products, or actively managing the duration (sensitivity to interest rate movements). These funds may enhance performance by gaining exposure to the volatility of other asset classes, such as equities.
3.Structured products are designed to use sophisticated instruments (futures, options or credit default swaps) to which individual investors usually have limited access. These instruments serve to optimise returns or limit losses while reducing sensitivity to a rise in interest rates or a fall in share prices. We recommend investing in short-dated defensive products (typically between 1 and 3 years). In other words, it is preferable to focus on investment products offering at least some protection of the invested capital. Underlying assets may include oil, gold, equity indices or interest rates
The risks of this theme are mainly opportunity costs in the event of risky assets continuing their upward trend. The risks inherent in the proposed investment solutions also relate to a sudden rise in interest rates, the default of an issuer, reduced liquidity in the event of market tensions, and exchange rate fluctuations.
We will seek to limit these risks by investing in alternative UCITs funds, Absolute return bond funds and structured products.