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Understanding Absolute Return Fixed Income

Mercer continues to support the role of growth fixed income assets as part of a well-diversified and balanced growth portfolio. The focus of this paper will be on absolute return fixed income, which can act as a useful diversifier within growth-fixed income portfolios. Specifically, this paper will re-introduce the strategy and its investment rationale, provide an overview of the different investment approaches/styles adopted by managers in the universe, and consider the case for absolute return approaches in the current environment; it concludes with thoughts on how investors might access these strategies.   

Absolute return fixed income strategies invest in a wide variety of global fixed income assets in a flexible and dynamic way with the aim of generating positive returns above a cash benchmark rather than a traditional fixed income market benchmark. To accomplish this, the strategies will opportunistically access a variety of (global) return sources, such as government bonds, interest rates, credit, currencies and emerging markets, taking both long and short positions.  

Managers will often market these strategies by arguing that they “aim to achieve positive returns in all market conditions,” including credit-spread-widening and interest-rate-rising environments   (which negatively impact traditional fixed income assets). Although many strategies fail to deliver on such ambitious goals, the returns of absolute return fixed income strategies tend to be much less dependent on the overall direction of fixed income markets and more dependent on manager skill. The better strategies have a focus on capital preservation as well as robust risk management   frameworks. Given their absolute return focus, an ability to identify managers that are able to consistently add value (or generate “alpha”) is of critical importance.

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