This article will explain what a Multi-Sector fixed income strategy is and why it is an approach that is relevant for investors who are looking to diversify their portfolio. Fixed income securities have traditionally, through its properties of low volatility and moderate returns offered a key role for investors to diversify their portfolio. As interest rates are at historically low levels, investors are struggling to justify investing in fixed income. Investors who are looking to diversify their portfolio away from equity strategies should consider a non-traditional fixed income approach.
Breaking down a Multi-Sector approach
To understand what a non-traditional fixed income MultiSector approach is, we should first define the two traditional approaches, core, and core-plus. The core fixed income strategy approach is often managed against an index, such as the Blomberg Barclays US Aggregate Index. The opportunity set is often constrained against index only constituents. Duration is typically managed close to the benchmark. The core strategy generates a low risk and can produce modest outperformance over the Blomberg
Barclays US Aggregate Index.
The core-plus strategy is similar to the core strategy but includes plus sectors. Plus sectors are non-index sectors, which is usually noninvestment grade rated. Most of the core-plus strategies allow 40% – 50% allocated to core-plus sectors. Examples of these sectors are High Yield and Emerging market debt. The duration is still managed close to the benchmark but often use derivatives and modest leverage. This results in a higher risk strategy but can also provide excess return twice the size of the core strategy.
Now when we know the traditional fixed income strategies, we can break down the Multi-Sector strategy. The Multi-Sector is similar to the core-plus approach but can be more dedicated to the plus sector. In some cases, the plus sector can constitute 100% of the portfolio and often little exposure to US Government Securities. The MultiSector has more discretion over duration exposure than the traditional approaches. They also have defined objectives that mainly focus on credit risk. As a result, the Multi-Sector are yielding higher than any of the traditional approaches.
An allocation to non-traditional fixed income can provide valuable benefits to a fixed income portfolio, including enhanced returns, higher yields, and uncorrelated returns while only increasing risk marginally.
This article is in our October Newsletter 2020
Max Römbo, MSc in Finance