With interest rates and bond yields stuck at or near historic lows, absolute return investing is attracting attention, and rightly so, though there are associated risks, according to Towers Watson.
The global professional services company believes that given the current interest rate environment, it is the ideal time for employers sponsoring 401(k) retirement plans to rethink their fixed-income investment options.
In “Unconstrained Bond Investing: Examining the case for absolute return strategies for DC participants,” Towers Watson investment consultants make the case for switching up to 25 percent of traditional U.S. aggregate bond asset to absolute return assets.
Absolute return investment techniques include using short selling, futures, options, derivatives, arbitrage, leverage and unconventional assets. Absolute return strategies pursue returns independent of a traditional benchmark index like the S&P 500 Index.
The Towers Watson team believes a plan sponsor should consider creating a diversified fixed-income fund option in which some assets would be allocated to a traditional bond aggregate strategy and some would be allocated to various absolute return vehicles, including unconstrained bond assets.
Towers Watson compared the merits of the strategic bond, the absolute return bond and the unconstrained bond against each other.
Absolute return bonds are “a step up in terms of complexity and sophistication,” and “create an all-weather portfolio that is robust across market environments,” according to Towers Watson, which notes that these funds have low interest rate sensitivity and should deliver strong returns over the medium term.
While noting that a key driver of returns for all these absolute return strategies depends heavily on manager skill, the consultants conclude that switching to an absolute return strategy can broaden diversification, increase the value proposition for plan participants and provide potentially better DC plan outcomes.