Video transcripts layout 1 | Insight Investment

Investors used to hold meaningful allocations to absolute return bond strategies, but that does not appear to be the case today. Why has interest declined?

There are two key reasons. The first is behavioral bias resulting from the previous macroeconomic regime, and the second is a tendency to underestimate the importance of diversification within investment portfolios.

Looking back to the 2010s, investors were often told that low-yield environments would favor absolute return strategies and allow them to outperform traditional total return approaches on a sustainable basis. However, that is not what occurred. While yields were indeed low, they continued to fall further, and credit spreads compressed steadily throughout the decade, supported by factors such as quantitative easing. As a result, beta-driven and traditional total return products continued to outperform, making it difficult for absolute return strategies to keep pace.

Another important factor was the relationship between risk assets and risk-free assets during that period. Correlations were largely negative, allowing fixed income and government bonds to serve as effective diversifiers within portfolios. We believe today's environment is different. Correlations may evolve, and investors may need to think more carefully about how they achieve diversification. Absolute return bond funds can be one way to address that challenge.

When considering the current market environment, it is important to ask how well beta is being rewarded. Valuations remain elevated, and many investors are concerned about the outlook for traditional market-driven returns. In our view, beta is not being rewarded as attractively as it has been in the past.

This is one reason why we believe now may be an attractive time to consider absolute return strategies. Four key factors support this view. First, beta appears relatively expensive. Second, investors can now earn meaningful yields from cash and short-term rates before making any active investment decisions. We do not expect a return to the low-interest-rate, low-inflation, and low-yield environment that prevailed before COVID-19.

Third, volatility remains a critical ingredient for active management success and for strategies that rely primarily on alpha generation rather than beta exposure. Today’s investment landscape is shaped by numerous uncertainties, including geopolitical developments, inflation risks, and fiscal challenges that policymakers continue to navigate. We do not expect volatility to disappear in the near future.

The fourth factor is the shape of the yield curve. Longer-duration bonds may face challenges if fiscal dynamics continue to place upward pressure on term premiums and government bond yields. At present, yield curves are not particularly steep, and the path of least resistance may be toward further steepening. In such a scenario, duration may not provide the portfolio benefits that some investors expect.

Taken together, these four factors create what we believe is a highly supportive environment for absolute return bond strategies. By focusing on alpha generation, diversification, and risk management rather than relying solely on market direction, absolute return approaches may be well positioned to help investors navigate today's evolving investment landscape.