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Fixed income allocations have experienced a difficult 12 months, with both performance and sentiment turning against the sector. The threat of higher interest rates has seen volatility in Government bond markets reach levels not seen in decades.

With many experts now suggesting that the duration “tailwind” is over, being the capital gains offered by bonds as interest rates fall, advisers have been forced to rethink the set-and-forget fixed income allocation. While many have turned to opportunities further along the risk curve, like credit and even ‘defensive’ equities, more flexible bond allocations have also benefited.

So much so, that the Franklin Australian Absolute Return Bond Fund, issued by global asset manager Franklin Templeton, recently hit $1 billion in assets under management. What has been particularly impressive is the fact that the fund had $500 million in assets under management in July 2020, so has doubled in the space of less than 12 months.  

As the name suggests, the Absolute Return strategy offers a more flexible approach to investing into ‘high quality,’ strongly rated corporate bonds. One of the key reasons, according to managing director of fixed income and portfolio manager, Chris Siniakov, is the realisation that “the current interest rate environment is here for some time and is creating challenges for investors seeking defensive returns without taking inappropriate risk.”

The fund is unique in that rather than simply tracking a benchmark like the Bloomberg Composite Bond index, the composition of which is ultimately determined by the level of indebtedness of a company or country, the manager seeks to “combine multiple lowly correlated alpha sources to deliver returns.” In this way, it aims to extract relative value opportunities through active management without taking on duration risk. This allows the fund to play a dual role of delivering stable returns through any interest rate or credit cycle, while protecting against volatility. This is achieved through a flexible mandate that allows duration between negative and positive 2.5 years.

According to the latest update, close to half the fund’s investments are in investment-grade corporate bonds and 40% in government securities with no exposure to high yield ‘junk’ bonds or riskier credit. The high-quality approach has delivered a return of 3.44% a year over the last five years without benefiting significantly from duration.

Commenting on the recent flows into the strategy, managing director of Franklin Templeton Australia, Matthew Harrison, notes: “with cash yielding extremely low rates of return and increasing concerns about inflation, we’re hearing from many investors concerned about the erosion of their wealth in inflation-adjusted terms. They are looking for ways to generate real returns and consistent income streams, but some are concerned about the level of risk in the broad fixed income and equity markets,” notes Harrison.

The absolute-return approach to fixed income is clearly proving attractive in this volatile environment.