However, this approach can introduce interest rate risk because the products are tethered to benchmarks comprised of high-quality, typically longer-duration issues (duration is a measure of general interest-rate sensitivity).
Further, a low-yielding environment likely reduces the diversification benefits of a fixed income allocation, and the portfolio’s sensitivity to interest rates can drag on returns if US Treasury rates rise for a prolonged period. In such an environment, adding liquidity and ballast in the form of traditional fixed income could prove expensive in terms of opportunity cost.
In contrast to traditional fixed income, nontraditional strategies that allow managers to opportunistically venture away from benchmarks can have more flexibility to emphasize the risk side of the risk/return relationship while seeking to actively mitigate the downside and limit volatility. The objective of most nontraditional approaches is to achieve attractive risk-adjusted returns, often within specifically defined volatility parameters.
Loomis Sayles is a longtime leader in nontraditional fixed income and has been managing strategies untethered to benchmarks for decades. As a complement to our multisector offerings, which can pursue opportunities globally, we manage Strategic Alpha—a nontraditional fixed income strategy with a global investment opportunity set.
Within the Strategic Alpha discipline, three basic tenets guide our investing:
HARVESTING AND PROTECTING RISK PREMIUM FROM THE MACROECONOMIC CYCLES
We begin by looking at macroeconomic factors. These typically drive credit cycles, which in turn can drive asset class behavior. Broadly speaking, there are three key risk drivers, or betas, that can be harvested within fixed income. We refer to them as the “3Cs”: Credit, Curve and Currency risk.
By properly identifying and analyzing the different phases of the macroeconomic cycle (credit repair, recovery, expansion/late cycle, downturn), Strategic Alpha seeks to profit from tactically adjusting exposures to these risk drivers throughout each phase. Comparing the anticipated base-case return potential against the downside risk helps assess whether an exposure is justified. We believe this approach is better equipped to produce a more stable risk/return payoff throughout various market and credit cycles than a tactical approach.
The unconstrained nature of Strategic Alpha enables us to cast a wide net for opportunities. Strategic Alpha has the flexibility to utilize and dynamically adjust each of the 3Cs in an effort to produce a well-diversified portfolio with the desired risk/return profile. Through the use of proprietary analytics, we attempt to estimate performance under various potential market conditions and adjust exposures and risk levels accordingly.
SEEKING NON-CORRELATED RETURNS
We believe a benchmark-agnostic strategy that combines top-down and bottom-up disciplines can produce returns from a variety of investments that have historically low correlation to traditional fixed income and equity allocations.
THE IMPORTANCE OF SECTOR AND SECURITY SELECTION
We believe fixed income markets are inefficient. Therefore, alpha can be obtained through thoughtful sector and security selection utilizing both quantitative and fundamental analysis.
Our quantitative analysis provides valuation tools to determine relative value and risk/return trade-offs across global economies and asset classes, while our fundamental analysis utilizes our proprietary research framework that focuses on intrinsic value (e.g., enterprise value) and margin of safety. One way we combine these analyses is with our Unified Relative Value Tool (URV), which aggregates quantitative and fundamental data and allows portfolio managers to efficiently drill down into sectors and individual securities to express investment ideas based on market inefficiencies and our analysts' views on specific securities (see chart below).
Strategic Alpha taps into Loomis Sayles’ deep macro, quantitative and research capabilities and insight from sector teams (made up of analysts, portfolio managers, strategists and traders).
In our view, the mitigation of drawdown risk should be a key component of any product designed to be an alternative to traditional core fixed income. Strategic Alpha has a stated risk tolerance of 4% to 6%i measured by standard deviation over a full market cycle. This target expectation is comparable to the historical volatility exhibited by most core and core-plus strategies.ii Managing to a stated volatility threshold drives many other investment decisions and demonstrates our focus on managing potential downside risk.
WHAT IS THE OPTIMAL NONTRADITIONAL FIXED INCOME EXPOSURE?
Plan sponsors and other investors should consider, among other factors, their risk and return profile, income needs and desired liquidity when evaluating nontraditional strategies. Loomis Sayles has been managing unconstrained multisector strategies with long-term total return objectives for decades, and we are seen by many institutional investors as leaders in this space. The Strategic Alpha strategy builds on these capabilities by leveraging the same deep, diverse research and risk management resources. We believe incorporating Strategic Alpha into a diversified portfolio can prove increasingly valuable as the market environment changes.
This report was originally published in October 2014. We have updated the content as necessary and otherwise believe the information is current and relevant.
iAlthough the investment manager actively seeks a targeted risk level, there is no guarantee the strategy will be able to maintain its targeted risk level.
iiSince-inception standard deviation of the Bloomberg Barclays US Aggregate Bond Index, a proxy for the investment universe, is 5.28%. (Data from January 1976 to March 2019; source: eASE Analytics System, eVestment Alliance.)
Past results are not necessarily indicative of future results.
This is not an offer of, or a solicitation of an offer for, any investment strategy or product. Any investment that has the possibility for profits also has the possibility of losses.
Commodity interest and derivative trading involves substantial risk of loss.
Bloomberg Barclays US Aggregate Bond Index is an unmanaged index of investment grade bonds with one- to ten-year maturities issued by the US government, its agencies and US corporations. Indexes are unmanaged and do not incur fees. It is not possible to invest directly in an index.
This paper is provided for informational purposes only and should not be construed as investment advice. Any opinions or forecasts contained herein reflect the subjective judgments and assumptions of the authors only and do not necessarily reflect the views of Loomis, Sayles & Company, L.P. Investment recommendations may be inconsistent with these opinions. There can be no assurance that developments will transpire as forecasted and actual results will be different. Data and analysis does not represent the actual or expected future performance of any investment product. We believe the information, including that obtained from outside sources, to be correct, but we cannot guarantee its accuracy. The information is subject to change at any time without notice.
Diversification does not ensure a profit or protect against a loss.
Key investment risks: credit risk, issuer risk, liquidity risk, interest rate risk, non-US securities risk, currency risk, derivatives risk, leverage risk, counterparty risk, prepayment, extension risk, equity risk, and non-diversified strategies .
This information is intended for institutional investor and investment professional use only. It is not for further distribution.
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