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Absolute Return Bonds Guide


There are four main investment strategies:
Directional Strategies
Here the manager will take a view on the overall direction of a bond market. Within the portfolio, he can establish long and short positions reflecting his expectations for individual markets after careful analysis of the likely moves in interest rates or currencies.
For example, the manager may wish to establish a long position in short-dated gilts if he felt that the market was being too bearish on UK interest rates.
Factors other than interest rates can also exert a key influence on government bond markets.
For example, in the US potential pension reforms could increase the demand for long-dated US Treasury bonds. The manager may therefore seek to establish a long position in US government bonds if new pension proposals were likely to provide additional support to the market.
Relative Value Strategies
Here the fund manager will look at the relative value offered by different types of bonds. He may therefore go long one government market versus another.
For example, the manager may prefer the prospects for UK government bonds relative to US Treasuries, and therefore 'go long' in gilts. He may also look further a field, when looking at the relative attractiveness of yield spreads. For instance, he may favour the prospects for Australian government bonds over UK gilts if he anticipated that Australian interest rates were likely to fall in relation to UK interest rates.
Yield Curve Strategies
Here the manager will assess the relative merits of bonds from the same issuer but with different maturity dates. He can therefore establish long or short positions in the relevant securities and/or derivatives of the same issuer.
For example, the manager may take the view that the prospects for shorter-dated bonds issued by a given company are better than those at the long end of the market, or vice versa.
It is also possible to take a view of likely movements across the yield curve and adopt positions designed to benefit from either a general flattening or an overall steepening of the curve.
For example, the yield curve for the Euro zone might be expected to 'flatten' on signs of higher interest rates. Generally short-dated bond yields could be expected to rise on the prospect of higher short term interest rates. At the same time, yields for longer maturities could prove steadier as such bonds may benefit from pension fund demand that is less sensitive to the outlook for interest rates. In this instance, the fund manager might 'go short' in short-dated issues, and 'long' in long-dated issues.
Sector Strategies
The difference in yield spreads between the various sectors of the bond markets can vary over time. Therefore, the manager can seek to exploit movements in the spread between bond markets to add value.
For example, non-government bonds could be sold in relation to government bonds if the manager expected the spread between the two asset classes to widen.
Given that the fund manager is not restricted to holding physical investments, instead of purchasing the bonds themselves, he could use derivative trades to exploit the movements in spread between the government and credit markets.
The manager may also take advantage of specific opportunities that arise within any given sector. For example, he may build a long physical position in an attractive new corporate issue that comes to market.
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