Aviva Investors
JOINED-UP FIXED INCOME DIVERSIFICATION
Dan James of Aviva Investors looks at how global diversified fixed income can provide a coherent solution in the search for alpha.
R
ather than simply being a choice between sovereign debt or credit, fixed income offers a wide choice of asset types and sources of returns that can be accessed by skilled, alpha-
generating fixed income teams. Aviva Investors’ outlook for most asset classes suggests that returns will be lower than those that investors have come to expect, with shorter and more volatile investment cycles. In view of this, investors should consider broadening their return sources to make good use of the opportunities available and reduce the volatility of returns.
However, it is important to ensure that the component parts of a
diversified portfolio work together to produce the desired level of risk/ return and make the best use of risk budgets. Global diversified fixed income provides one such co-ordinated approach. It is designed to bring together the best
investment ideas from autonomous and relatively
unconstrained alpha-generating fixed income teams into a coherent, risk-controlled portfolio that also incorporates a market returns (beta) replication strategy.
DIVVYING UP THE RISK BUDGET In a global diversified strategy, risk budgets are assigned to alpha teams
who are responsible for delivering performance that fulfils these budgets. The aim is to ensure that portfolio risk is managed at the individual alpha team level by skilled investors who know their holdings and trade positions intimately, and are therefore in the best position to manage this risk. The strategy’s overall risk parameters are maintained throughout the investment cycle by reallocating risk budgets between alpha teams as economic and market conditions dictate.
So how does one decide whether, and how much, to allocate to each
alpha-generating team? The key to this lies in understanding where we are in the investment cycle and relating this analysis to the expected performance of fixed income asset classes. Having established this, it is possible to assign allocations to alpha-generating fund management teams in a structured and intelligent way.
It is important to stress that we are talking about the alpha-generating capabilities of specialist teams within specific fixed income asset classes, rather than teams that simply gain a market exposure to the asset class.
This is necessary if superior risk-adjusted returns are to be delivered with a lower volatility than one would experience by being long or short in the underlying asset classes.
A BROAD CHURCH The diversification of returns in a global diversified strategy is therefore
achieved not just through exposure to different fixed income asset types, but also by exposure to distinct manager styles. Further diversification of returns is available through alpha teams that have different time horizons. A sovereign debt alpha team might have a long-term bias to five-year interest rates based on fundamental factors, while a quantitative strategies alpha team might hold a short-term short position. Holding both positions in appropriate proportions is, nonetheless, rational because they are likely to aid diversification, enhance returns and reduce overall portfolio risk over the investment cycle.
COMMAND AND CONTROL Given the range of approaches and the objective of achieving a portfolio
of uncorrelated returns, it is crucial to understand how each alpha team delivers returns throughout the investment cycle. Of course, there is no value in allocating risk to a team that has limited ability to use that risk at that point in the cycle.
Furthermore, the allocation of risk must be monitored regularly. Events
such as the rapid widening of credit spreads (the extra yield from corporate bonds over sovereign debt) in 2007 highlight the importance of continually assessing liquidity conditions when assigning risk budgets to alpha teams.
Global diversified fixed income provides a high degree of flexibility
in addition to well-defined risk controls. Inherent in the risk-budgeting process is a high level of insight into where performance is coming from and the levels of risk being taken to achieve it.
Dan James is head of global aggregate portfolio management at Aviva Investors. For more details, please visit
www.avivainvestors.co.uk
October 2011 | INTELLIGENT INSURER | 43
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