Allocating Based on Risk in Fixed Income Markets
In a wide-ranging conversation with The Wall Street Transcript, Peter Strzalkowski, co-team leader of OppenheimerFunds’ Investment Grade Debt Team and Portfolio Manager of Oppenheimer Total Return Bond Fund, Oppenheimer Limited-Term Bond Fund, and Oppenheimer Limited-Term Government Fund, discusses how he thinks about risk and structures portfolios to seek the best risk-adjusted returns.

Risk Budgeting and the Value of a Shorter Investment Horizon

Pete describes the multidimensional risk framework embedded in his team’s portfolio construction process in investing across the investment-grade landscape. “Rather than seeking yield in return, we allocate based on how much risk, how much tracking error, we can take against the benchmark, and then allocate accordingly to the highest Sharpe ratio that we can foresee.” A short investment horizon of between three to six months, depending on the strategy, enables more flexibility, as “markets are dynamic and looking at what things will be like six months from now with respect to rates or credit, or just about anything else, is a futile task. So rather than doing it that way, we have a risk budget: we allocate based on where we think the best spots are, and change accordingly when things change.”

Impact of Rising Interest Rates

Pete notes that the funds typically eschew any material interest rate and yield curve bets. The team maintains that trying to anticipate interest rate swings is difficult, and would rather deploy that risk spend in other sectors of the market. As a result, in terms of sensitivity to rising rates, the funds’ durations are typically in line with their benchmarks.

Importance of Knowing What’s in Your Fixed Income Portfolio

Pete emphasizes downside risk management, particularly in the later stages of the credit cycle. Exposure to riskier securities is a key element for investors to consider, even across investment-grade funds. “If the Fed goes too high and the cost of funding goes up, it will affect levered debt the most – a lot of which is held in investment-grade funds, not just in high-yield funds. If that happens, we could see a short-term reckoning that’s not pretty, with potentially a real lack of liquidity with this paper in the Street.” In this regard, Pete touts his funds’ avoidance of risker areas of the market, such as collateralized loan obligations, B and below rated high-yield securities, and emerging market debt.

Read the full discussion with additional insights into the bond market.