Beyond the bonds | Insight Investment

A common misconception that we often encounter about fixed income investing is that it can't be used to generate material positive total returns. The return drivers are certainly different in fixed income to in equities, where in equities it's much more about earnings growth, multiple expansion, or dividend payments.

In fixed income, it's contractual income, and the starting level of income today actually means that forward-looking returns are most likely positively skewed, and if we get a fall in interest rates and a fall in government bond yields, the total returns available could start to rival those that you'd historically associate with equity investing.

What distinguishes our fixed income strategy is actually the evidence that it's performed historically in various different market environments. Why that's important is that we can actually embrace that evolution rather than having to fear it. How we go about navigating different environments is firstly maximizing the number of relative value decisions that we've got. That means combining top-down asset allocation with bottom-up security selection. But beyond that, it allows us to respond to these environments that will have different drivers.

For example, 2020, much more about the top-down decisions. What's your aggregate exposure to markets? 2022, much more about relative value decisions between regions, Europe versus the US, and the most recent environment, much more about your stock picking at a company level, picking the winners and avoiding the losers.

How we balance quantitative factors with human intuition when managing fixed income portfolios is firstly recognizing the benefits of a quantitative approach. That's either efficiency or it's edge.

Within fixed income, one of the key differences with equity investing are the volume of different instruments or securities that we can invest within. For investment-grade corporate bonds alone, there's around 20,000 different bonds that we can choose from. Quantitative techniques can therefore make it much faster for us to see the relative value opportunities, but we still need a human intuition to interpret the data.

And beyond that, in a marketplace that is still driven by human decision-making, we need to be aware of behavioral biases that humans have. First of all, so that we're aware of them, but secondly, so we can take advantage if those human behaviors are creating an inefficiency.

How we approach risk management beyond the numbers is firstly recognizing that risk management and risk-taking are just as important when it comes to portfolio management.

We work with an independent investment risk team who are specialists in trying to understand the risks in our strategies, trying to illuminate the different types of risks that we might be taking. But our underlying belief is there is no single perfect risk metric.

That means looking at a number of different factors from the traditional, such as sensitivities to changes in government bonds or corporate bond prices, but also thinking about scenario analysis.

And we can use historic scenarios, which will give us a guide, but history often rhymes, but it won't repeat. And that means where humans can get involved, they can think about the what ifs. The what ifs may be, is there a change in correlation between government bonds and corporate bonds? Is the risk today much more in the government bond sector than it is in the corporate bond sector? Using that human intuition to supplement the more traditional way of thinking about risk management.

Why we haven't heard more about Insight Investment is because we've been going about our business very quietly. We focus on one thing. All we do is fixed income, but our client base has predominantly been institutionally up until now. And those institutions, it's much more about the quality of investment delivery, much more about the client experience that we can give them, rather than spending on a big advertising budget.

Being part of the BNY family means that we can use their distribution, use their brand, so that under BNY Investments banner, we can deliver our institutional quality investment solutions and bring it to a broader audience

The common misconceptions that I've encountered is, one, that certain types of investors think fixed income is dull, and they think active management doesn't work. How we address this is showing them the evidence.

Strategies that have a broad asset class opportunity set and diversified across regions deliver stronger headline returns, risk-adjusted returns, and have lower drawdowns through time, the more regionally and asset class-specific concentrated strategies. The other way is we show the evidence that when we're dealing with the passive-active question, that fixed-income strategies that are actively managed, even by the median managers, consistently outperform through all major time periods the benchmarks they're trying to outperform. Really due to the exploitation of the inefficiencies in these markets, which is the same reason that passive ETFs struggle to get close to the returns of benchmarks, particularly net of fees, that it's very difficult to replicate those complexities.

The defining moment for me was in and around the COVID pandemic, where we came through a period of relative stability for risk markets, and then suddenly we had a black swan event that made risk markets move very violently and really only beaten in magnitude by what we saw in the global financial crisis in recent times.

But actually, the speed of sell-offs was even faster. So at that point, you had to take a deep breath, focus on the process, think about the forward-looking, rather than getting too emotional about what has just transpired.

The unpredictability and challenging market is what makes our job interesting. It's the time where you really need to be on your game and focus on those opportunities to drive that attractive return and consistent alpha that we're trying to deliver for our clients through time. And it's those periods where the market isn't challenging or is predictable that actually is somewhat more challenging. But in those periods, you need to stay focused and realize that a volatility event might just be around the corner.

The key part of the culture and ethos that has really resonated with me is doing the right thing. Now, that might seem simple and maybe even slightly cheesy, but it goes far beyond just doing a good job. From a client perspective, it means partnering with them, trying to spot new ways of working and doing things, and tailoring a solution that gets to that outcome in the best, most efficient way. Spotting risks ahead of time and partnering with them to deliver that solution. That really means we're their trusted partner. They become a great client advocate for us. We're able to grow their business and our business symbiotically.

We are absolutely forensically focused on risk management to deliver the most optimal risk-adjusted returns for our clients. It's not about return maximization. It's about providing attractive, consistent risk-adjusted returns that keeps us competitive versus our peers.

One common misperception about fixed income is that it's there just to provide income, as the name would suggest.

That can be true, but the reality is that it's, depending on how you structure it, available for a number of different purposes, whether it's doing that, providing growth, which is one that people miss, providing stability of cash flows, providing diversification for clients' broader portfolios of investments.

All of those are possible depending on how you structure the fixed income investment you make. Another misperception in fixed income is that you need stable markets in order for fixed income to do well.

The reality is that might be true for some types of fixed income strategy, but for many of our fixed income strategies, beating the market requires volatility because dislocations happen, there are opportunities to exploit as a result.

At the moment, volatility is relatively low, so you have to work that much harder to do so in the current market environment.

One thing we really, really emphasize that you should not do is fall into the classic trap of assuming volatility remains low forever, loading up on a load of risk and thinking everything will be fine just at the wrong point when the market turns. That's how people get caught out.

You've seen it again and again over the years.

We're well aware of that, so we make sure we don't fall into that trap.

A number of things distinguish our approach in fixed income.

I'd say a couple of important ones to highlight, particularly for today's environment, would be, first of all, that we have 160 plus investment professionals based in UK and the US. That's not maybe that distinguishing, but the way we organize them is. So each of those investment professionals are part of a small group of people focusing on a particular area of fixed income in great detail, so they can really have the best chance of adding value and spotting opportunities.

Then the second factor that is equally important to make that setup successful is we have a highly collaborative team structure fostered by people like me, where through a structured investment process, those ideas are brought together, evaluated, and ultimately through challenge, we end up with a menu of fixed income ideas that everybody can take away as appropriate, depending on what their clients are looking for. That, I think, is how we get very strong ratings from some of the big investment consultants and other people who assess our business regularly.

Well, a key challenge at the moment, for example, is linked to another common misperception about fixed income, and that's that fixed income needs stable, low volatility markets to be successful.

That's true in some cases, but actually more often than not, when you're trying to add value and beat the fixed income market as an active manager, you need volatility, because that way you get dislocations and opportunities arising.

So a challenge at the moment is actually that volatility is relatively low in many ways relative to history. To deal with that, you could, as some people fall into the trap of doing, load up on lots of risky assets thinking, "Well, hey, volatility is low and that's going to be the case for a long time, so I'm just going to take more and more risk." We've seen that play out in the past.

That's when you end up having crises, big sell-offs, and those people who've done that get really, really damaged. So we're conscious of that, and we make an ongoing assessment of when the risk-return is attractive and when it is not.

And we just have to make sure that when volatility is low, we don't fall into those sort of traps.

To make sure our investment approach remains aligned with the evolving needs of our clients, the way we are set up becomes crucial.

Being conscious of all the different ways that you can invest in fixed income to achieve different things immediately allows you to adapt the emphasis on those different ways of investing, depending on what the client's preferences for risk and reward are. The other aspect that equally makes us very well-positioned to evolve with our clients is that specialist structure I talked to.

So depending on what exactly the client wants us to emphasize or de-emphasize within the whole fixed income world, as well as their goals, again, allows us to very quickly move between the different teams that we have in terms of that relative emphasis and really get the best results that they want.

We are also constantly assessing our investment process and looking for opportunities where we can bring in modern technology without changing fundamentally what we do, but just making it more efficient and more effective.

So we have a number of quantitative researchers who help our traditional fixed income portfolio managers with doing exactly that.

And from time to time, we're gradually introducing better ways of doing that and applying technology across the whole process as well.