And should you invest in one? Jeff Ringdahl explains how his firm’s flexible bond fund goes long or short using three levers: Credit, currency, and yield curve. He says the fund can complement a traditional bond fund, or be used in its place.
Kate Stalter: We’re talking about fixed income today with Jeff Ringdahl, Chief Operating Officer at American Beacon.
Now, Jeff, as everybody listening to this is well aware, we’re in a low-interest-rate environment, and a lot of people have become hesitant about any kind of fixed-income investment. But I understand that Beacon has a fairly new fund that can address some of these concerns through flexible bond investing. Maybe you can tell us about that today.
Jeff Ringdahl: Yes, sure thing Kate, thank you. We have what we’ve called our Flexible Bond Fund (AFXAX).
It’s a fund that we launched in July 2011, and we had been working on that fund for the better part of almost two years before we brought that to market. We’ve had our eyes on flexible bond investing for that length of time as we have anticipated market environments that may be fairly challenging for your traditional bond investor.
Really, the premise behind that is: Not only are interest rates low, which reduces income and the yield on your staple bond index, which is the Barclays US Aggregate Bond Index, just north of 2%—I think it’s just under 2.1% at the end of April. So, you’ve got very little income, but you’re at historically low interest rates as well.
We’ve subscribed to this concept of fixed-income beta. A lot of folks pay attention to equity beta and how volatile your equity portfolio is, relative to the broad movements in the market, whether you are more or less volatile.
We think that it’s just as relevant to talk about fixed-income beta, because traditional bond funds are driven by large macro factors, the predominant factor being the movement in interest rates and, particularly last year, when rates in the ten-year Treasury went from the mid-to-high threes all the way down to about 1.75%.
Maybe even over 100% of the return that was experienced in traditional bond funds was experienced through duration risk. That they were essentially long on duration and it was interest rates that drove that portfolio, not other decisions that could be made in a portfolio, or other investments that could be made in a portfolio.
That’s great in a steeply declining, fixed-income environment, but those don’t happen that often, and most folks wouldn’t bet that it would happen again here with rates being where they are. You know, today they are just under 2% now, so we are at historical lows on the ten-year Treasury rate.
Another thing to think about here is that there’s a double whammy effect with traditional bond investing, where you are very much tied to the direction of interest rates and which way they go. One, is not only are we at historical lows in real yields, they’re actually below zero, so after inflation you’re actually losing money.
But second is, there is an additional effect of low rates, which is that not only are they low, but your duration actually descends as yields come down, because you have less and less income that’s going to come to an investor in the years before maturity of a bond. And so actually, the same bond that is at 4% has a longer duration than the same bond at 2%.
Take the ten-year Treasury: the ten-year Treasury at a 4% yield is less risky, less sensitive to interest-rate changes than a ten-year Treasury at 2%. So, you got the double whammy of low income and a bond that’s going to behave a lot more like a zero-coupon bond, where it’s sensitivity to interest-rate changes is greater. So, it’s a double whammy of the risk that rates go up and that you are actually more sensitive to it.
So, we’ve been quite constructive on a product that introduces a lot of flexibility to bond investing, and one that actually is less sensitive and, hopefully, quite insensitive to interest rates in the broad US bond market. And there’s a number of ways we do that, Kate, with the product that we have.
One is that the product is unconstrained relative to geography, so when we talked about the sensitivity of the ten-year Treasury or even the Barclays Ag—the ten-year Treasury clearly is a US issuer only, but even the Barclays Ag has a very miniscule, almost a de minimis amount of non-US exposure, maybe it’s 5% of 7% of non-US exposure.
So you’re subject to one yield curve, the movements in one yield curve. It ought to be wise for investors to diversify across many yield curves across the world, because what we’ve experienced here is that, in any given year, you have such a wide disparity of return outcomes in different countries.
Even within developed countries, if you just take away the emerging-market countries—which can behave quite differently and currencies can move quite dramatically—but you look just at the developed world and at G7 or the G20 world, you have thousands of basis points of spread between the highest and the lowest performing country. So you have the ability to not only diversify, but also find additional return opportunities. So you ought to be diversified across geographies.
You also ought to have flexibility in your duration, the risk in the portfolio, and flexible bond investing requires that. So the funds that we’ve developed have the possibility to be negative five years in duration, positive eight years in duration. It’s a very wide band of duration. We don’t anticipate that our sub-advisors would end up using that amount of flexibility, but it exists in the portfolio when the conviction is there among the sub-advisors to position their portfolio accordingly.
But what that says to you, the fact that the portfolio could theoretically be negative duration, means that it could actually profit from a rising interest-rate environment if positioned appropriately and timed appropriately. And a traditional bond fund simply lacks that constraint or lacks the flexibility.