Deep Dive: Endowus Low Volatility Fixed Income Portfolio

What is the Endowus Low Volatility Fixed Income Portfolio?

The Endowus Low Volatility Fixed Income Portfolio offers investors enhanced downside protection with comparable returns to the broader fixed income market. Through  a curated blend of unconstrained, total return and short duration fixed income funds, this portfolio balances diversification, downside protection and total return potential to achieve the desired investment outcome.

The portfolio aims to provide investors exposure to the global fixed income market at a lower volatility.  It is globally and sectorally diversified, with a short duration focus and an overall average investment grade credit rating.

Geographically, the Portfolio has a meaningful allocation to the United States, which has the largest fixed income market, followed by Asia and Europe. It also has a small allocation to emerging markets.

Sectorally, the Portfolio consists primarily of corporate bonds, which in the current environment provides higher yield and hence better risk-adjusted return potential. Government bonds and securitised bonds make up the rest of the Portfolio.

Which funds make up the portfolio?

The Endowus Low Volatility Portfolio is a curated portfolio of six best-in-class funds selected by the Endowus Investment Office following extensive screening of hundreds of funds. The funds are managed by global leading fixed income fund managers such as Brandywine Global Investment Management, Dimensional Fund Advisors, Fullerton Fund Management, Lion Global Investors, PIMCO, and UBS Global Asset Management.

Underlying funds in the Low Volatility Fixed Income Portfolio

The portfolio is constructed by balancing key considerations such as diversification, downside protection and total return potential in order to achieve the desired investment outcome.

Three funds are short duration funds, which help to reduce duration risk and lower volatility of returns. Two funds are managed with an unconstrained style, dynamically allocating to different sectors based on market cycles of risk, which could potentially enhance returns through cycles. Finally, a total return fund is included to anchor the portfolio with its stable sector and credit allocation.

Why invest in fixed income

Fixed income helps investors to build a more balanced and diversified portfolio

Allocation to a globally-diversified fixed income portfolio helps to build a more balanced portfolio suited for investors’ different circumstances . For illustrative purposes, we will be using the Barclays Global Aggregate Index, the most all-encompassing benchmark, to represent the fixed income universe. As the table below shows, a 20% allocation to fixed income reduces the portfolio volatility by 20% and improves the return/risk ratio by 12% compared to a pure equity portfolio.

Fixed income provides downside protection during market volatility

Additionally, the equity markets are volatile and historically have suffered large drawdowns. A strategic allocation to fixed income dampens the loss when it is most needed. During the six largest equity market drawdowns since the global financial crisis (GFC) in 2008, the global equity market from its top to bottom has suffered losses on a scale of -8.5% in Q1 2018 to -52.3% during the GFC. In contrast, the global fixed income market proved to be resilient during the worst-performing periods of global equity markets, as the chart below shows. The protection that fixed income provides helps investors to not get spooked by the sudden losses and stick to their long term investment plan.

Short duration corporate bonds to play defence and offence

While there is a valid reason to add fixed income to one’s overall portfolio for diversification, some investors are still concerned with the impending uncertainty due to upcoming rate hikes. In particular, there might be heightened volatility with the beginning of the Fed tapering. While this is a valid concern, instead of shying away from fixed income investments altogether, investors can consider shortening the duration of the fixed income portfolio as well as increasing allocation to corporate bonds. The former offers potential defence in a rising rate environment, and the latter preserves the total return prospect as corporate bonds pay higher coupons than government bonds. Corporate bonds would potentially benefit from a recovering economy due to improving corporate fundamentals, resulting in tighter credit spreads.

The below chart illustrates how such a combination has worked in past episodes of rate increases. Generally, short duration investment grade corporate bonds have realised less than 1% loss, or at times, even positive returns, while longer duration credit and treasury were hit much harder by the rising rates.

Who should invest in Low Volatility Fixed Income Portfolio?

As explained above, it is generally desirable for investors with a lower risk profile to have some allocation to fixed income investments. However, this does not mean that fixed income is entirely safe - it still has volatility and drawdown, and depending on the specific allocation, the level of volatility varies.

The below chart visualises this for us. During the GFC, the global credit market suffered a maximum drawdown of -11.3% while the short duration credit market only experienced -4.2% maximum drawdown. However, the flip side is that we see a clear relationship between the level of volatility and the long term growth of wealth. It is therefore important for investors to be cognisant of one’s own risk tolerance and return objective when deciding upon fixed income allocation.

Why should you invest in the portfolio?

Lower volatility and interest rate sensitivity

As mentioned above, we believe it is crucial for investors to have an efficiently-designed fixed income portfolio suited for one’s risk tolerance. While the 100% fixed income portfolio offered in Endowus Flagship Portfolio should still be our clients’ preferred fixed income solution, we hear some investors desire to have a lower volatility version. Additionally, we do recognise certain investors’ preference to have more protection in a rising rate environment.

We therefore created the Low Volatility Portfolio, which is  designed to have a lower volatility and interest rate sensitivity than the 100% fixed income portfolio offered in Endowus Flagship Portfolio. We have intentionally limited the duration of the Portfolio to be around four years and curated a combination of actively managed funds to achieve the highest potential return given the risk taken.

The below charts put it in perspective: the portfolio’s realised risk has been commensurate with the duration and credit risk it takes and it has achieved a lower volatility and maximum drawdown than the Endowus Flagship Portfolio and the global credit market overall.

Superior risk-adjusted return empowered by active management

In terms of return, the portfolio is not expected to outperform the Endowus Flagship Portfolio and the Bloomberg Barclays Global Aggregate Credit benchmark, as the fundamental rule in investing remains: higher risk should be compensated by higher return.

However, the portfolio is expected to be rightly rewarded for the amount of risk it takes — and it has.  Based on an investment horizon between December 2018 and October 2021, it has realised a better return to risk ratio than both the Flagship Portfolio and the global credit market benchmarks.

The Portfolio’s underlying funds are more active and dynamic in nature. We believe that there is room for active managers to deliver superior risk-adjusted returns by harvesting different alpha opportunities in the vast fixed income universe. By combining different lowly-correlated active funds, we improve this result even further.

Ongoing assessment of underlying funds by Endowus Investment Office

The current underlying funds have been selected by Endowus to be the best-in-class against their peers after thorough due diligence. The Endowus Investment Office (IO) continues to follow each fund’s performance, risk, and portfolio activities and assess the fund’s quality against peers, as well as its suitability for the portfolio.

The IO team also continues to research and down-select new funds that can further add value to the portfolio. This assessment helps to ensure that the Portfolio continues to be invested in the best-in-class managers and is responsive to ongoing developments/new ideas.

Learn more about how you should approach a core-satellite portfolio investment strategy here. For details on how Endowus manages your portfolios amid market volatility, refer to this article.

Appendix: Portfolio details

Portfolio allocation of the Endowus Low Volatility Fixed Income Portfolio

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