In this piece from Citywire, Barings portfolio manager David Nagle discusses the importance of understanding the risk/return profile of a short-term bond strategy.
Short-term bond strategies have been consistently popular among investors seeking to protect their capital while also generating a return. These strategies are generally considered lower risk on the spectrum of potential investments, and investors may choose to invest in short-term bond strategies for a number of reasons, including:
- The potential for enhanced cash and higher total returns versus money market funds
- The potential for lower volatility versus equities or other higher-risk markets
What some investors may not realize is that within this space, the risk / return profile of short- term bond strategies can vary quite dramatically. One firm’s strategy may be made up of short-term U.S. Treasuries, for instance, while another’s may comprise a combination of longer-term corporate bonds and derivatives—although both are considered short-term strategies, the two have very different risk / return profiles. Given the potential for variation within the short-term bond universe, it is crucial that investors look closely at the makeup of a portfolio before making an investment and ask themselves: Where is the risk (and return) coming from?
Two Ends of the Spectrum: Benchmark Huggers vs. the Wild West
From a risk/return perspective, many short-term bond funds fall into one of two categories relative to the index. As follows, the degree to which these funds deviate or tilt from the benchmark becomes the primary driver of performance.