Sean Dranfield, CEO and principal at Performance Trust Asset Management, has said investors should embrace the idea of combining return profiles because you cannot predict rate cuts.
The US fixed income manager entered the European ETF market in September via white labeller HANetf.
The Performance Trust Total Return Bond UCITS ETF (PTAM) lies in contrast to most other European bond strategies available today – with the strategy being “rate agnostic” – offering protection whether rates rise or fall.
The ETF mirrors Performance Trust’s $8bn Total Return Bond fund in the US, which launched 14 years ago.
Actively managed, the US fund has returned 3.3% versus 1.8% for its reference benchmark over a 10 year period, the BBgBarc Aggregate Bond index.
Instead of making broad predictions about interest rate movements and then shifting investments to defensive strategies to protect against rising rates, PTAM contains bonds that offer protection whether rates rise or fall.
It does so through its ‘shape management’ approach, which ignores rate predictions and focuses on understanding the bond's underlying price drivers, modelling total returns across different rate scenarios.
‘One stark difference’
Dranfield noted one “stark difference” between the US and European bond markets – the smaller size of the securitised market - is the reason the latter has not seen a bond strategy like this before.
Many rate-insensitive bonds are in the securitised market – such as asset-backed securities (ABS) and CLOs (collateralised loan obligations) – which Dranfield noted is a “significantly smaller” market in Europe.
The European securitisation market has lagged the US, particularly after slowing since the great financial crisis.
Since then, US annual average issuance has generally been around ten times larger than Europe, according to a report from Deutsche Bank Research.
Despite differences in market dynamics, PTAM’s portfolio includes a portion allocated to securitised bonds and uses corporate bonds rated BBB or below to bolster the ‘defensive’ or less rate-sensitive segment of the portfolio.
Dranfield added top-down interest rate calls are the approach most competitors take, where they attempt to predict whether interest rates will rise or fall and then adjust their bond holdings accordingly.
“Most of our competitors are making top-down calls, I do not think they are willing to say that they cannot predict interest rates. Let us just embrace this idea that we need to combine different total return profiles because we actually cannot predict rates,” he said.
Potential challenges ahead
Dranfield noted the challenges that lay ahead for Performance Trust in the European ETF market lie with the asset class itself and with education surrounding the firm’s methodology.
“I think there is an educational aspect to what we do.”
“People really have not heard the shape management story before. This is no different than the US, as we find that when you illustrate the flaws with duration as a risk metric, or the flaws with yield or rate predicting, it is not necessarily something that they have heard before,” he explained.
“Through persistence and time and trust building, that can be certainly overcomeable,” he added.
For ETFs specifically, Dranfield noted European ETF market is slightly behind the US market in terms of its adoption of more traditional active strategies.
“I imagine that might take a little bit of time too, but it seems like Europe tends to follow in terms of ETF product appetite. I think that it will just take care of itself.”
More to come?
Dranfield said he can see Performance Trust launching a global bond fund that combines the defensive strength of US bonds with offensive opportunities wherever the global landscape looks attractive.
“Based on what I know so far about the European bond market, creating that level of defensive might be more challenging, but I still believe a global bond fund would be the next logical step.”
