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Flexible bond funds have become increasingly popular. Being benchmark unaware, their portfolio allocation can shift quickly over time and across fixed income asset classes – and sometimes beyond. However, these dynamics and the diversity in flexible bond funds make them difficult to evaluate and compare. In our white paper ‘Navigating through flexible bond funds’, we provide a list of focus points that can help.
Flexible bond funds are not tied to an index. The portfolio manager has a holistic view and can steer the portfolio towards the areas where he sees most opportunities. The diversity and dynamics in the investment strategies of flexible bond funds therefore justify greater demands on their risk management process and transparency.
Flexible bond funds need to be transparent in order to prevent negative surprises for investors. First of all, the investment universe needs to be clear. Is the fund a real bond fund or are there also large exposures to foreign currencies, or to other asset categories outside the fixed income market, such as equities? The fund also needs to be transparent on the current risk profile and the potential dynamics of this profile. What are the fund’s exposures to risk factors such as interest rates and credit spreads? The primary risk measure is total return volatility rather than tracking error.
The fund needs to provide insight in to the risk contributions within the portfolio across different dimensions, such as positions, sectors, regions and foreign currencies, as well as risk factors such as interest rates and credit spreads. How does the portfolio manager evaluate risk-reward trade-offs and translate them into the fund’s positions? A risk attribution reveals what asset classes or risk factors are likely to generate portfolio returns. The relative size of the risk contributions impacts the degree of portfolio diversification and reflects the relative views and convictions of the portfolio manager.
The Sharpe Ratio is the risk-adjusted performance measure of total returns. Maximizing the Sharpe Ratio requires aligning the contributions to risk and reward within the portfolio. Fully integrating risk management in each step of the investment process allows for evaluating risk-reward trade-offs within the portfolio, balancing the risk contributions of positions and controlling overall portfolio risks.
In our white paper we provide a list of focus points and also evaluate Robeco’s flagship total return bond fund Robeco Global Total Return Bond Fund on these points.