Rising yields combatting inflationary pressures are conducive to active bond managers outperforming passive strategies, according to an expert investment manager.
IOOF portfolio manager of fixed income Osvaldo Acosta said in this environment, active bond managers have the opportunity to enhance portfolio returns and protect their capital in ways not typically available to passive managers.
The US Federal Reserve lifted interest rates twice in just three months to 1%, and hinted two more increases in 2017 and another three in 2018. In Australia, the market has removed further rate cut expectations by the Reserve Bank but is factoring in rate increases in bond prices over the next two years.
Passive mangers holding long-dated bonds can over-expose portfolios to interest rate duration risk. Active managers however, have the flexibility to shift their portfolios to shorter duration assets, or at any point on the yield curve to minimise capital losses, Acosta added.
Active managers have the prerogative to invest in the financial instruments best-suited to different interest rate environments, he said.One option available is investing in floating rate notes which have minimal duration risk.
"If you or your clients believe rates will indeed rise, a floating rate note will take advantage of these interest rate rises with minimal negative impact to the capital value of the underlying bond," Acosta pointed out.
Other options not available to passive managers are investing in more complex financial instruments such as interest rate derivatives, inflation linked bonds, credit options and investing in different international markets or adding currency investments to a portfolio.
"Bonds will always play a key role in a diversified portfolio however, in times of rising interest rates an active manager will be better placed to uncover better risk/returns," he said.