In the lower-for-longer monetary policy dominated world, how should investors approach investing in fixed income? Should it be from a top-down or bottom-up perspective?

Peter Martin:  I lean more to a multi-asset approach with a bottom-up stock selection. This should be done in the context of a top-down overview, just to make sure the risks are managed and that you look at it holistically. It’s about trying to generate some return from somewhere in a sensible risk fashion; I am wary of people pushing the envelope and taking the risk too far in the lower-for-longer tight credit spread environment. Andres Sanchez Balcazar: The macro drivers are far more important at the moment than the bottom-up; you need to be very, very careful about the type of macro risks that you take. It would be more towards an 80% top-down and at best 20% bottom-up view, in the sense that refinancing is very available for maintaining idiosyncratic risk in credit. Default rates are very low and so the differentiation in returns that you’re likely to obtain in your security selection bucket is very little, whereas your portfolio can be subject to a number of macro forces. If you just focus too much on the bottom-up then you are going to be run over by the volatility. Edward Farley: Obviously, macro is a key driver. However, with corporate spreads across the board much tighter than they were, this is an environment where detailed bottom-up analysis is critical. There are all sorts of pitfalls within individual names, where just relying on the top-down view could lead to holding some issues that may blow-up. Martin: The more you get in to areas which people are less familiar with, such as emerging market credit, then the bottomup is very important. But you still need to be aware of what the US Treasuries curve is doing and how that would impact in terms of the tactical strategic allocations to these markets. Salman Ahmed: The central banks’ usage of fixed income as a policy tool is unprecedented. During the Great Depression the lowest yields were 2.5% in the US and the economic fundamentals were way worse than what we have encountered over the last 10 years. And now there is a strong geopolitical influence as well. Also due to regulations, banks are unable to provide liquidity, which has huge implications for portfolio management. So in fixed income markets usage of market cap benchmarks are heavily challenged in this environment because you can’t get in and out as quickly as you used to before. Martin: The market cap benchmarks are very much unconstrained and Libor-plus approaches are how you get the best ideas to get the best risk-adjusted return. People are perhaps not abandoning those market cap benchmarks but they’ll become less important over time. You just have to work harder and smarter to get returns and to embrace new areas. These days there’s much more product in distress, opportunistic credit. As these things are looking to fund quite quickly, so you need the understanding to get the money quickly enough. Investors all of a sudden can afford to be lenders, direct or otherwise and syndicated. You have to embrace new language like trade finance or regulatory capital which sounds scary at first but when you understand it, is quite helpful. Ben Shaw: From my experience there are quite a lot of niche bond-like instruments you can buy. We’re quite a small scheme relatively, so to buy a couple of million, five million of something actually can turn the needle and be worthwhile, whereas if you’re a billion pound scheme it’s not going to do that. Kate Hollis: That’s when you’ve got to be really careful about people reaching too far for yield, particularly in private markets. You have so much less transparency on what’s going on and you could have a strategy which does beautifully for a couple of years and then suddenly blows up, because the fund manager is taking on too much money and reaching too far to allocate the capital. Christine Farquhar: But do investors really think about fixed income as lending money and thinking about, “We’re going to hold this until it matures”? Part of the problem is investors regard high quality fixed income as a cash machine, an ATM. “Yes I’ll put it in that government bond fund but if I need cash, I’ll just take it out tomorrow”. Shaw: As a pension scheme only five to 10% of your liabilities crystallise in any one year in a worst case scenario and therefore you can afford to lock up chunks of capital. Quite often a bond fund might be one of those areas where you don’t need to lock it up because that’s your area of liquidity or if you’ve got equities, equities can be your liquidity. Martin: But again, it’s what you’re using that bond money for. If you need bonds to be liquid – if you have a collateral call, if rates do rise – then you need those monies to be obtained. Ahmed: But what is cash equivalent fixed income now? Due to the Basel III liquidity coverage ratio, banks will be forced to hold more sovereign debt and the ECB is holding more than 30% of German outstanding debt; it’s going to be 35%, it’s going to be locked on their balance sheet. This is not investor-based locking, this is regulatory non-investor based locking and a significant chunk of the free float is out of the market. So the question is what is cash now? Because the flexibility between bond and cash is broken. Because the repo market volumes in German debt is collapsing at the moment so if we think, “Oh I have this bond and I’m going to go and repo it in the market and get cash” there is a problem because that market may collapse. Farqhuar: And in the old days liquidity in bond markets was, “I’ll sell the bond”. Nobody says that now, it’s repo, it’s borrowing.