singaporeen
Protection with the Zero-duration share class

Protection with the Zero-duration share class

11-07-2013 | Insight

Long-term interest rates are more likely to rise than fall. This makes it particularly interesting to invest in the Robeco Zero-duration share class, because bond prices react inversely to yields.

How can corporate-bond investors protect themselves against a possible rise in long-term interest rates?

Zero duration lowers interest-rate sensitivity. The Robeco Zero-duration share class is created using interest-rate swaps.

  • Yields on US and European government bonds rose after reports that the Fed could begin tapering back its bond purchases;
  • Robeco offers a Zero-duration variant that protects the regular share class against a rise in the long-term interest rates;
  • Some peers in the market offer so-called short-duration funds, but these have serious drawbacks versus our Zero-Duration offering:
  • Robeco offers Zero-duration variants for High Yield Bonds, Investment Grade Corporate Bonds and Financial Institutions Bonds.

Robeco Singapore Private Limited

12 Marina View 
#10-02, Asia Square Tower 2 
Singapore 018961 
Email: robecosg@robeco.com
Tel: +65 6909 6898

Contact

Yields rise after Fed policy statements

Yields on US and European government bonds rose after reports that the Fed could begin tapering back its bond purchases later this year if the US economy keeps improving. Figure 1 shows the 5-year German Government Bonds and US Treasury yields (in %).

Currently, the Fed is buying USD 85 billion each month in treasury paper and mortgage-backed securities to stimulate economic and jobs growth. Bond investors expect this to be the starting point of a Fed policy that is less accommodating to the bond market. They fear that the Fed might raise short-term interest rates after 2015 in order to fight inflation.

In the euro zone, the situation is different: the ECB has pledged that interest rates will remain at record lows far into the future. The euro-zone economy is still weak.

Figure 1: 5-year German Government Bonds and US Treasury yields (in %)
Source: Bloomberg

Zero-duration share class - how does it work?

Robeco offers a Zero-duration variant that protects the regular share class against a rise in the long-term interest rates, while investors can still try to take advantage of higher credit spreads.

The Zero-duration share class invests in the existing portfolio and includes an interest-rate hedge. This hedge lowers interest-rate sensitivity by swapping the 5-year interest rate for the money-market rate (Libor 3 months). This means that Robeco pays the fixed interest rate while receiving the floating interest rate. The result is a lower sensitivity to interest rates. The investor can still benefit from potential credit-spread tightening. The expected returns on high-yield bonds are twofold: the credit spread and the interest rate. The swap makes the interest-rate component variable. When government bond yields rise, the Zero-duration share class is expected to outperform the regular share class.

Implementing this hedge lowers the yield of the portfolio. This difference currently amounts to about 1.5%. As the current duration of the Robeco High Yield fund is around 4.4 years, the interest rates only have to rise by about 35bps in order to break-even between both share classes (duration x rate increase) and to compensate for this yield give-up. In a scenario of stronger rate increases, the Zero-duration share class is expected to deliver higher total returns than the regular share class.

Case study: investing in Robeco High Yield

High-yield bonds offer investors attractive credit spreads: the current US high yield credit spread is 480 bp on government bonds. Figure 2 shows the US high yield credit spread since 1994. But what is the best way to reap the benefits of this credit spread, when long-term interest rates can have a major impact on total returns?

Robeco High Yield Zero Duration offers protection against a further rise in long-term interest rates by exchanging the 5-year swap rate for the 3-months swap rate.

The cumulative performance difference (in %) between the zero and regular high-yield share class is shown in Figure 3 (red line) together with the development of the 5-year swap rate (blue line). They can be seen to have moved more or less in line. The performance of the Robeco High Yield Zero-duration share class versus the regular class can also be seen in Figure 3. The Zero-duration class outperformed the regular share class in recent weeks as a result of increasing interest rates.

The return on a high yield bond corresponds to a yield on a comparable government bond plus a credit spread (higher interest rate) to compensate for the risk associated with a high-yield investment.

The regular Robeco High Yield share class offers a yield of 6.4%, consisting of a long-term interest rate of 1.7% and a credit spread of 4.7%. The sensitivity of the interest rate and of the credit spread is 4-5 years.

The Robeco Zero-Duration share class offers a yield of 4.9%, consisting of a short-term interest rate of 0.2% and a credit spread that is also 4.7%. The sensitivity of the interest rate component is reduced to around zero, while the sensitivity of the credit spread is around five years.

The Robeco High Yield fund manager expects returns in line with yields for the next twelve months of around 6.4% (as per end of June 2013. Following the recent yield increase, he has been adding slightly more risk to the portfolio by adding some bonds that repriced disproportionately. The credit beta of the fund has been increased from underweight to neutral (beta is 1). In the US, there have been outflows in high-yield ETF holdings, represented by predominantly tactical investors. This has been much less the case with actively managed funds like Robeco’s High Yield fund.

The fund manager believes that the search for yield is not over yet, and that investors might add risk to their portfolios once the markets stabilize somewhat. On the back of the relatively weak economy, it remains key to focus within the high-yield universe on the strongest companies able to weather the storm. Robeco High Yield therefore avoids the weakest issuers.

Figure 2: US high-yield credit spreads from January 1994 (in %)
Source: Barclays

Figure 3: Cumulative performance difference (in %) between Robeco High Yield Zero Duration (0DH) and regular Robeco High Yield (DH) and performance of 5-year swaps (in %)
Source: Robeco

Short-duration fund alternatives have drawbacks Some peers in the market offer so-called short-duration funds. These funds are invested in bonds with short maturities only. These alternative funds have serious drawbacks versus our Zero-Duration offering:

  • Investable universe is limited. A short-dated bond fund has a smaller investable universe, because it cannot use all maturities. This makes it more difficult to build a well-diversified portfolio. On the other hand, Robeco’s portfolio manager can select long-duration bonds if they are attractively priced. This increases the opportunity for alpha generation.
  • Illiquidity. Short-dated bonds tend to be subject to less liquid trading. This can lead to higher trading costs.
  • Higher call risk. This risk (i.e. that a bond issuer will take advantage of the callable bond feature and redeem the issue prior to maturity) is more prominent in bonds with shorter maturities. The higher call risk leads to an uncertain risk/return profile and interest-rate sensitivity.
  • Lower yields. Short-duration bond funds offer considerably lower yields on the portfolio compared to the Robeco Zero-duration share classes.

A switch from the regular share class to the zero-duration share class is easily done without any buying or selling of bonds, simply by trading in the interest-rate swap, a highly traded financial instrument.

The Zero-duration strategy is implemented by state-of-the-art systems with a strong focus on operational and financial risk management. Robeco’s risk-management system includes the use of derivatives, and risk is measured on a daily basis.

Robeco offers Zero-duration variants for High Yield Bonds, Investment Grade Corporate Bonds and Financial Institutions Bonds. Robeco can also offer tailor-made solutions to decrease duration.

Interested in what the Zero-duration share class can do for you? Please contact your account manager to check availability.

For professional investors only. The value of your investment may fluctuate. Past performance is no guarantee of future results.

Read also: Zero duration to protect against rising yields

Important information

This information is for informational purposes only and should not be construed as an offer to sell or an invitation to buy any securities or products, nor as investment advice or recommendation.
The contents of this document have not been reviewed by the Monetary Authority of Singapore (“MAS”). Robeco Singapore Private Limited holds a capital markets services license for fund management issued by the MAS and is subject to certain clientele restrictions under such license.
An investment will involve a high degree of risk, and you should consider carefully whether an investment is suitable for you.

Subjects related to this article are:
Logo

Important Information

Warning/Important note: This website contains information which is only available to qualified investors as defined below. If you are not a qualified investor, please click “I Disagree” to leave the website.

By clicking on "I agree", I declare that: 

  • I am a qualified investor as defined under 1
  • I have read and understood the Terms and Conditions and Disclaimers as described under 2

1 - This website may only be accessed directly or indirectly by the following persons in Singapore:

1) “institutional investor” under section 304 of the Securities and Futures Act (Cap.289)(“SFA”), which means:
(i) the Government; (ii) a statutory board as may be prescribed by regulations made under section 341 of the SFA; (iii) an entity that is wholly and beneficially owned, whether directly or indirectly, by a central government of a country and whose principal activity is (A) to manage its own funds; (B) to manage the funds of the central government of that country (which may include the reserves of that central government and any pension or provident fund of that country); or (C) to manage the funds (which may include the reserves of that central government and any pension or provident fund of that country) of another entity that is wholly and beneficially owned, whether directly or indirectly, by the central government of that country; (iv) any entity (A) that is wholly and beneficially owned, whether directly or indirectly, by the central government of a country; and (B) whose funds are managed by an entity mentioned in sub-paragraph (iii); (v) a central bank in a jurisdiction other than Singapore; (vi) a central government in a country other than Singapore; (vii) an agency (of a central government in a country other than Singapore) that is incorporated or established in a country other than Singapore; (viii) a multilateral agency, international organisation or supranational agency as may be prescribed by regulations made under section 341 of the SFA; (ix) a bank that is licensed under the Banking Act (Cap.19); (x) a merchant bank that is approved as a financial institution under section 28 of the Monetary Authority of Singapore Act (Cap.186); (xi) a finance company that is licensed under the Finance Companies Act (Cap.108); (xii) a company or co-operative society that is licensed under the Insurance Act (Cap.142) to carry on insurance business in Singapore; (xiii) a company licensed under the Trust Companies Act (Cap.336); (xiv) a holder of a capital markets services licence; (xv) an approved exchange; (xvi) a recognised market operator; (xvii) an approved clearing house; (xviii) a recognised clearing house; (xix) a licensed trade repository; (xx) a licensed foreign trade repository; (xxi) an approved holding company; (xxii) a Depository as defined in section 81SF of the SFA; (xxiii) an entity or a trust formed or incorporated in a jurisdiction other than Singapore, which is regulated for the carrying on of any financial activity in that jurisdiction by a public authority of that jurisdiction that exercises a function that corresponds to a regulatory function of the Authority under this Act, the Banking Act (Cap.19), the Finance Companies Act (Cap.108), the Monetary Authority of Singapore Act (Cap.186), the Insurance Act (Cap.142), the Trust Companies Act (Cap.336) or such other Act as may be prescribed by regulations made under section 341 of the SFA; (xxiv) a pension fund, or collective investment scheme, whether constituted in Singapore or elsewhere; (xxv) a person (other than an individual) who carries on the business of dealing in bonds with accredited investors or expert investors; (xxvi) the trustee of such trust as the Authority may prescribe, when acting in that capacity; or; (xxvii) such other person as the Authority may prescribe.

2) “relevant person” under section 305(1) of the SFA, which means:
(i) An accredited investor; (ii) a corporation the sole business of which is to hold investments and the entire share capital of which is owned by one or more individuals, each of whom is an accredited investor; (iii) a trustee of a trust the sole purpose of which is to hold investments and each beneficiary of which is an individual who is an accredited investor; (iv) an officer or equivalent person of the person making the offer (such person being an entity) or a spouse, parent, brother, sister, son or daughter of that officer or equivalent person; or (v) a spouse, parent, brother, sister, son or daughter of the person making the offer (such person being an individual).

3) any person who acquires the units [in a collective investment scheme] as principal if the offer is on terms that the units may only be required at a consideration of not less than $200,000 (or its equivalent in a foreign currency) for each transaction, whether such amount is to be paid for in cash or by exchange of units in a collective investment scheme, securities, securities-based derivatives contracts or other assets, and if the following condition is satisfied: (i) the offer is not accompanied by an advertisement making an offer or calling attention to the offer or intended offer; (ii) no selling or promotional expenses are paid or incurred in connection with the offer other than those incurred for administrative or professional services, or by way of commission or fee for services rendered by any of the persons specified in section 302B(1)(d)(i) to (vi) of the SFA; and (iii) no prospectus in respect of the offer has been registered by the Authority or, where a prospectus has been registered (A) the prospectus has eAccxpired pursuant to section 299 of the SFA; or (B) the person making the offer has before making the offer 1. informed the Authority by notice in writing of its intent to make the offer in reliance on the exemption under this subsection; and 2. taken reasonable steps to inform in writing the person to whom the offer is made that the offer is made in reliance on the exemption under this subsection.

4) Or otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA.

If you are not any of the types of persons described above, you are not authorized to enter this website and you should leave this website immediately.

2 Terms and Conditions
You acknowledge that you have read these Terms and Conditions (“Terms”) prior to accessing the website located at www.robeco.com/sg (“Website”) and you agree to be bound by the Terms.  If you do not agree to all of the Terms, you are not an authorised user and you should not use the Website. The Website is owned by Robeco Singapore Private Limited (company registration number: UEN. 201541306Z), which is licensed by the Monetary Authority of Singapore (“MAS”) pursuant to the Securities and Futures Act (Cap.289) (“SFA”) of Singapore, and is managed by Robeco Singapore Private Limited and/or its affiliates (collectively, as “Robeco”). The Website is intended for and should be accessed by institutional investors or accredited investors (as defined under Section 4A of the SFA) of Singapore.  The Website is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation or which would subject the Robeco to any registration or licensing requirement within such jurisdiction.  It is your responsibility to observe all applicable laws, rules and regulations of any relevant jurisdiction. The content contained in the Website is owned by Robeco and/or its information providers and is protected by applicable copyrights, trademarks, service marks, and/or other intellectual property rights.  You may not copy, distribute, modify, post, frame or link the Website, including any text, graphics, video, audio, software code, user interface, design or logos.  You may not distribute, modify, transmit, reuse, repost, or use the content of the Website for public or commercial use, including all text, images, audio and/or video.  Robeco may terminate your access to the Website for any reason, without prior notice. Neither Robeco, nor any of its associates, nor any director, officer or employee accepts any liability whatsoever for any loss arising directly or indirectly from the access of the Website.  You agree to indemnity and hold Robeco, its associates, directors, officers or employees harmless against any and all claims, losses, liability, costs and expenses arising from your use of the Website due to violation of the Terms. Robeco reserves the right to change, modify, add or remove any parts of the Terms at any time and for any reason.  The Terms shall deemed to be effective immediately upon posting. The Terms shall be governed by, and shall be construed in accordance with, the law of Singapore.

Disclaimers
The Website has not been reviewed by the MAS. Accordingly, the Website may not be accessed directly or indirectly to persons in Singapore other than (i) to an institutional investor under Section 304 of the SFA, (ii) to a relevant person pursuant to Section 305(1), or any person pursuant to Section 305(2), and in accordance with the conditions specified in Section 305, of the SFA, or (iii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA. 

Nothing in the Website constitutes tax, accounting, regulatory, legal or investment advice.  The Website is for informational purposes only and should not be construed as an offer to sell or an invitation to buy any securities or products, nor as investment advice or recommendation or for the purpose of soliciting any action in relation to Robeco’s businesses, or solicitation by anyone in any jurisdiction in which such an offer or solicitation is not authorised or to any person to whom it is unlawful to make such an offer and solicitation. Any reproduction or distribution of information from the Website, in whole or in part, or the disclosure of its contents, without the prior written consent of Robeco, is prohibited.  By accessing to the Website, you agree to the foregoing.  

The funds referred to in the Website are for information only.  It is not a recommendation or investment advice, nor does it mean the funds is suitable for all investors.  The contents of the website is not reviewed by the MAS.  Any decision to participate in the funds should be made only after reviewing the sections regarding investment considerations, conflicts of interest, risk factors and the relevant Singapore selling restrictions.  You should consult your professional adviser if you are in doubt about the stringent restrictions applicable to the use of the Website, regulatory status of the funds, applicable regulatory protection, associated risks and suitability of the funds to your objectives.

Any decisions made based on the information contained in the Website are the sole responsibility of yours.  Any investments made or to be made shall be with your independent analyses based on your financial situation and objectives.  The investments and strategies contained in the Website may not be suitable for all investors and are not guaranteed by Robeco.  

Investment involves risks and may lose value.  Historical returns are provided for illustrative purposes only and do not necessarily reflect Robeco’s expectations for the future.  The value of your investments may fluctuate.  Past performance is no indication of current or future performance.  The Website may contain projections or other forward looking statements regarding future events or future financial performance of countries, markets or companies and such projection or forecast is not indicative of the future.  The information contained in the Website, including any data, projections and underlying assumptions are based upon certain assumptions, management forecasts and analysis of information available on an “as is” basis and without warranties of any kind, whether express or implied, and reflects prevailing conditions and Robeco’s views as of the date published or indicated, and maybe superseded by subsequent events or for other reasons.  The information contained in the Website are accordingly subject to change at any time without notice and Robeco are under no obligation to notify you of any of these changes.  Robeco expressly disclaims all liability for errors and omissions in the information presented in the Website and for the use or interpretation by others of information contained in the Website.

Robeco Singapore Private Limited holds a capital markets services licence for fund management issued by the MAS and is subject to certain clientele restrictions under such licence.  An investment will involve a high degree of risk, and you should consider carefully whether an investment is suitable for you.

I Disagree