Investors are facing difficult decisions about reinvestment strategies and how to generate return in a sustained low interest rate environment. How to improve yielding strategies without changing the allocation weights and avoiding illiquid assets? Within the fixed income context, yield enhancement leads to a yield pick up under the same risk basis or under a higher risk bucket (drivers of yield enhancement to fixed income investors are mainly the four following risk factors : duration, credit, convexity and private debt).
To fit this goal, what types of fixed income strategies can investors set up ?
- Vanilla solutions
A basic option for direct investments, is to monitor where is the best opportunity within the issuer curve (checking the Carry, the Roll Down, the Risk Reward).
At equivalent rating, duration and currency, why not switching to an other bond issuer.
An other option is to switch the government bonds to unique bonds that are implicitly/explicitly guaranteed by the government or a provincial government.
An other option is to allocate to higher yielding fixed income assets, such as assets that investors probably don’t have exposure to today (high yield and bank loans, private debt or loans).
And an other option is securitized assets (collaterized loans as CLO, lease and other asset-backed loan solutions… offering diversification and shorter duration).
- Derivative solutions
Securing solution : to prepare reinvestment and thus lock strategy return. The use of Forward Bond is to secure return : it starts from a bond maturity already owned. The underlying asset of such strategy could be Supra-National/Agency/Peripherals, Emerging with deep and liquid outstandings.
Transformation solutions : to gain pick-up thanks to moving a bond structure to an other one :
– The use of Cross Currency Basis Swap to enhance return within one issuer multi-currency curve : a Supra-National/Agency/Corporate bond in foreign currency structured with an asset swap and a cross currency basis swap to get finally a EUR bond with a yield pick-up compared to the former EUR bond curve.
– The use of swap to turn a linker (Inflation-Linked Bond) into a fixed rate bond, and thus provide a duration and a yield pick-up versus traditional debt purchase.
Through this note, was presented a brief range of fixed income strategies improving portfolio return. Yield enhancement could be also reached through structured products : those products offer a regular income during product lifetime and are suited for investors expecting a sideway or slightly rising movement of the underlying.
Moreover, yield enhancement could have an other meaning : instead of dealing with a gain of basis points due to a fixed income investment or relative value strategy, it could also be brought through risk management strategy entitled downside risk protection. That’s another topic that will be covered in another article.