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Pictet-Absolute Return Fixed Income: unlocking the potential of a rapidly-changing bond market
Pictet Asset Management May 2014

For professional investors only

Overview

From 16 to 9. Over the past decade, the number of sovereign borrowers rated triple-A by Standard and Poor's has almost halved. There is probably no clearer testament to the damage caused by the financial crisis. But it is not the only momentous change facing fixed income investors. In another break with the past, policymakers in the developed world no longer worry about the moral hazard of intervening in the capital markets. Driving down real interest rates close to zero has been the policy of choice in the US, UK and Japan, while in the euro zone it has become de rigueur to encourage banks to buy the bonds of those governments with the weakest credit credentials. If dealing with unorthodox monetary and fiscal policies is not challenging enough for fixed income investors, traditional bond benchmarks – and the strategies tied to them – do not help matters. In fact, they often amplify risks. Because these indices are capitalisation- or, perhaps more accurately, liability-weighted, they expose investors to the governments and corporations that issue the most debt. This not only leaves participants vulnerable to the potentially unfavourable shifts in borrower creditworthiness, it also restricts their access to more attractive investment opportunities elsewhere. The bond investor’s plight is further complicated by a recent deterioration in market liquidity. The introduction of more stringent financial regulations has forced large investment banks to cut back on fixed income trading. With marketmakers in shorter supply, trading conditions in the secondary market are worsening. Volatility has risen as a result. It is due to these shifts that the investment climate in fixed income is becoming the

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