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.
Mutual funds and exchange traded funds are subject to market risk and volatility. Shares may gain or lose value.
Fixed income investing entails credit and interest rate risks. When interest rates rise, bond prices generally fall, and a fund’s share prices can fall.
Tracking error is the difference in the return earned by a portfolio and the return earned by the benchmark against which the portfolio is constructed.
Sharpe ratio is a risk-adjusted measure of rewards delivered per unit or risk. The higher the Sharpe ratio, the better.
Duration measures interest rate sensitivity. The longer the duration, the greater the expected volatility as rates change.
The yield curve is basically the difference between interest rates on short-term United States government bonds, for example, two-year Treasury notes, and long-term government bonds, like 10-year Treasury notes.
The mention of specific securities, issuers or sectors does not constitute a recommendation on behalf of any fund or OppenheimerFunds, Inc.
These views represent the opinions of the Portfolio Manager at OppenheimerFunds, Inc. and are not intended as investment advice or to predict or depict the performance of any investment. These views are as of the publication date, and are subject to change based on subsequent developments.