Fixed Income

Shaping Fixed Income Funds to Meet Changing Needs

December 1, 2016
The market demands that some of our clients will face over the next 20 years likely will be very different than those they’ve faced over the past 20 years.

Key Points

  • A challenging market environment creates a demand for new strategies that can help meet investors' changing needs.
  • Clients may want active investment options that do not exactly follow a benchmark.
  • Fixed income is invariably used to play a role in an overall asset allocation.

Today’s fixed income investors face a challenging market environment. Low interest rates, volatile markets, and a broad uncertainty about economic growth—both domestic and globally—have created demand for new strategies that can help meet investors’ evolving needs. Arif Husain, T. Rowe Price’s head of International Fixed Income, explains how the firm’s products are adapting to meet those changing needs.

Q. What, if anything, surprised you when you arrived at T. Rowe Price three years ago?

A. When you’ve had 50-plus interviews, you don’t really expect to find anything you didn’t already know about. But there were a couple of surprises. First was the breadth of research around the globe, which was hugely impressive. Second was the risk management infrastructure—I didn’t expect to find something as flexible, practical, and informative. And it’s not just me making that observation—a lot of clients and consultants have also said that to me.

Q. Did you make many changes early on?

A. The idea was that we wouldn’t have to change things too much. Perhaps one of the main things we have changed is to reduce the internal meeting times and make them more accessible for associates around the world—meetings are very important, but I felt they could be done in a better way. Another change has been to back our highest convictions a little more. If you have an analyst team with the capabilities of ours, the client should benefit as much as possible from their differentiated insight. On the margin, that has meant taking bigger positions in our highest-conviction ideas.

I try to encourage a lot of healthy conflict within the investment process. This means more discussion, with people encouraged to express their views in a forthright way. That’s how you reach conviction—through open and honest discussion.

Q. How has the fixed income fund lineup evolved since you arrived?

A. When I arrived at the company, I sat down with senior fixed income associates to discuss whether the existing funds met client needs and, more importantly, whether they would continue to do so in the future. We all agreed that our current set of strategies was still very relevant in meeting client needs, but it also became clear to us that the challenges some of our clients will face over the next 20 years were probably going to be very different than those they’d faced during the previous 20 years. Those clients would probably need additional strategies.

Our Global Unconstrained Bond Fund (RPIEX), for example, originated as a solution for an Australian institutional client and was then offered more broadly. Essentially, it’s a fund that recognizes in a low-yield, high-volatility environment, you might not want to follow the benchmark.

Q. Are there plans for many new funds?

A. There will be a gradual pipeline of new products to address changing market conditions. We don’t create funds to fill the shelf—we do it to meet client needs. One of the reasons that we can be quite slow to launch new funds is that we want to be extremely thoughtful during the process. We work closely with clients to truly understand their needs and then spend a lot of time ensuring that we design something that actually meets those needs.

“We strongly believe that generating a compelling level of alpha consistently is a better way of serving clients than simply trying to achieve the highest possible level of alpha...”

Q. What steps do you take to ensure that new products meet client needs?

A. Underpinning our process is a simple question: “What do our clients want from their bond allocation?” This is something that we need to ask ourselves every day—because the answer may be different for each client and will also change over time. There are very few investors who want to invest 100% of their portfolio in fixed income. Fixed income is invariably used to play a role in an overall asset allocation—and our job is to make sure it plays the role our clients want it to.

Sometimes individuals invest in bonds to generate higher returns and income, for example, through emerging market debt or high yield debt. However, for others, fixed income is used as a defensive anchor in a portfolio. It’s not the highest-returning asset class in the world, but it can be of enormous value to clients if we can achieve these defensive characteristics.

Q. How does T. Rowe Price differ from the competition?

A. We strongly believe that generating a compelling level of alpha consistently is a better way of serving clients than simply trying to achieve the highest possible level of alpha, which can result in some managers not being there for their clients when they are most needed.

In recent times, some asset managers have launched funds that do not achieve what they say they will. There are bond funds that have the volatility characteristics of equity strategies, while at the same time some equity managers have tried to mimic bond strategies by delivering half the volatility. It’s as if they want to swap places, with neither delivering what they’re supposed to. We strongly believe that our fixed income funds should do what our clients expect them to.

How the Fixed Income Market Has Transformed

Yields are lower and interest rate risk has increased since the global financial crisis.

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Yield to maturity is the expected annual rate of return earned by investors in market price bonds, assuming that the bonds are held to maturity and all coupon and principal payments are made on schedule. Duration is a measure of a bond’s sensitivity to interest rate changes: The higher the duration, generally the more bonds will lose in value as rates rise and the more they will gain if rates fall; the reverse is true—the lower the duration, bonds will generally lose less if rates rise and gain less if rates fall.

Lines represent yield and duration of Barclay’s U.S. Aggregate Bond Index.

Sources: Barclays and T. Rowe Price.