Investec selector: don’t rely on passive advantage in bonds

14-Jan-19
Rue Irving

Darren Ruane, head of fixed interest at Investec Wealth & Investment, says the advantages of investing passively in fixed income will diminish over the next five to 10 years.

‘There is going to be a significant amount of dispersion between the outcomes of bonds and equities and we think in that scenario there will be greater opportunities with active managers, which favours active strategies going forward,’ he says.

That said, Ruane does like using ETFs in fields where it is difficult to outperform, such as in the government bond space.

Here, he says, ETFs allow you to focus on specific parts of the fixed income universe. For example, if you want a 0- to five-year fund, that’s exactly what you can get.

‘It is harder to generate alpha from short-dated bonds so ETFs can be effective here. Whereas in high yield you’d want to have an active manager,’ he says.

An edge in equities
Overall, Ruane thinks passive strategies are more effective for investing in equities than in fixed income.

‘The big difference between bonds and equities is that with bonds, if you get a company that goes wrong, you can potentially lose all or a lot of your money because there is asymmetric risk,’ he says.

‘In the last 10 years there hasn’t been much default in high yield markets, so having an ETF would have been fine. But looking ahead with QE and worries about the US economy, we think that active strategies are more important in high yield and emerging market debt.’

Brexit hedge
One reason Ruane employed an ETF recently was to insure against a bad Brexit outcome.

‘One of the most obvious ways is to buy an overseas currency and the one we favoured was the US dollar. When the dollar was trading against sterling at 1.40, we decided to put a position on in dollars.

‘We thought that even though there would be an upwards movement in short-dated US bond yields, any downside from the yields going up would be more than mitigated by the strength in the currency were there to be a negative outcome from Brexit,’ he says.

‘We bought a one to three-year US government ETF from iShares – the main call was on the currency rather than the bond. We thought that by minimising duration we would minimise price losses and so we focused on the currency part. We have made money on that trade because the cable at the time was 1.40 and it’s now 1.30.’