Multi Asset Boutique

No interest – no problem: how multi asset can work with negative interest rates?


Risk premia – the most sustainable sources of return

As investors transition into a new decade, their sources of investment returns remain the same – risk premia.

What is a risk premium?

When investing, you expect to be compensated for taking risk, for example for entrepreneurial risk or the risk of a change in interest rates. The more risk you take, the higher the reward should be. This so-called “risk premium”, i.e., the excess return over a risk-free investment, such as cash, should offset any short-term losses to deliver outperformance over the long-term.

Risk premia are the most sustainable sources of return, and the two most important risk premia are equity and fixed income. For equities, the risk is a market downturn, while for fixed income the risk is rising interest rates that lead to falling bond prices.

Multi asset investors typically rely on these two risk premia as the basis of their portfolio. However, risk premia fluctuate over time. Therefore, investors should apply a dynamic approach to managing their exposures to capture timely opportunities and achieve an optimal performance outcome for a given risk budget.

In this, the first in a series of two articles, we will look more closely at how dynamic investing into the fixed income risk premium works. Our follow-up article will be dedicated to the equity risk premium. Spoiler alert: This article will not give you a fixed income return forecast for 2020 because, as evidence-based investors, we have no crystal ball and only a short-term view into the future.

The fixed income risk premium needs dynamic management

With over 12 trillion US dollars of bonds delivering negative yields, many clients are asking: “Can you still make money in fixed income?” Indeed, the fixed income risk premium fluctuates significantly over time, but you can generate performance with dynamic management rather than a buy-and-hold approach.

A good dynamic approach should result in an optimized government bond portfolio. Why only government bonds? This way, you can capture the fixed income risk premium in its purest form, without credit risks that typically have some degree of overlap with equity risk premium, as the underlying asset of the company is usually financed by both equity and bonds.

The 3 main patterns of the dynamics of the term structure: Carry, Mean Reversion and Momentum

At Vescore, we apply a systematic approach to capturing the fixed income risk premium. Empirical evidence demonstrates that all relevant information is reflected in the term structure of interest rates and so the current shape of the yield curve can be used to derive short-term predictions.

What is the “term structure” of interest rates?

Other than in simplified economic models, in reality there is no single interest rate. There are various maturities of government bonds outstanding, so the yield for a 1-year government bond will typically be different to that of a 30-year government bond. The so-called “term structure” encompasses the interest rates of bonds for all maturities.

We rely on three main patterns here:

1.    Carry: Carry is the result of the change in a bond’s price purely from the passing of time. As a bond “rolls down the yield curve” (e.g. moves from 10-years to 9-years maturity), its price will change based on the slope of the interest rate curve. As yield curves are usually positively sloped, this delivers a positive roll return, even when the entire yield curve is in sub-zero territory, as illustrated in chart 1.


2.    Mean Reversion: The further the level, shape, and curvature of the yield curve move away from their average, the more likely they will come back to their mid-term equilibrium, allowing the investor to position for an eventual correction.
3.    Momentum: On the other hand, interest rates show trend-following behavior in the short run. If interest rates have declined in the recent past, they are likely to decline further today, as more investors follow the trend.

We evaluate these components to derive the optimal positioning on the particular yield curve in question.

As a result, our model (“FINCA”) prescribes an optimal duration for the fixed income allocation of our multi asset portfolios. Chart 2 illustrates this for our flagship fund, the Vontobel Fund II – Vescore Active Beta. As shown by the black line, this approach has led to a dynamic management of our portfolio’s duration over the last eight years (the model’s track record goes back to 1999 and can be provided upon request).


Indeed, the previous year provides a clear example of how a dynamic approach can add value at times when interest rates are low or even negative.

2019: A case study on the benefits of tactical duration management

For our flagship strategy, we invest in the four most liquid government bonds globally, including German government bonds. Going back to the beginning of 2019, yields for German government bonds were already in negative territory, so not exactly something many multi asset managers would have a big appetite for.


However, our Carry and Momentum models put us into a strong long position from the beginning of 2019 until end of July 2019 with a position of up to 64.1% of the portfolio’s value invested in German bund futures, as shown in chart 3. This enabled us to benefit from one of the best global bond markets in 2019. We scaled back our position in August due to greatly reduced contributions from Carry and Momentum. Thereby, our models were able to anticipate the September to December 2019 drop in prices.

What was the impact of our dynamic approach to fixed income for our portfolio? Well, taking 2019 for example, our flagship fund: Vontobel Fund II – Vescore Active Beta AI produced a 12-month return of 16.3%; 6.0% of which came from our fixed income allocation (institutional share class, net of fees, in Euro).

How can you benefit in 2020?

As we enter the new decade, the two scenarios for fixed income are an increase of yields into positive territory again, or a further extension of the low-yield environment. Low interest rates are not a new phenomenon. Indeed, we saw rates increasing from low levels already in 2016, as German 10-year rates moved from -0.19% to 0.40%. Back then, based on strong trends, the duration in our flagship fund went down to as low as one year. This low duration was able to protect investors’ capital in conjunction with our equity allocation.

However, 2020 might play out differently, without a move back to higher yields, but dynamic markets. Even in such a scenario, our approach to fixed income can deliver value. In particular, carry should help to generate income even in places where yield curves are in negative territory. Also, the two markets with higher rates, the US and Canada, can provide opportunities as we individually manage our allocations to each of our four rates market, enabling our models to perform.

Regardless of what surprises 2020 will have in store for investors, with a track record of over 18 years, we provide an academically proven and successful alternative to a typical buy-and-hold approach. The fact that there is no interest should not be a problem for your multi asset investment.




Description Vontobel Fund II - Vescore Active Beta EUR AI LU1617166936
Index n/a
Currency EUR
Inception Date 21.04.2002
Time period 21.10.2002 - 31.12.2019
Rolling 12-month net returns (in %)
31.12.2019 - 01.01.2019 16.3
31.12.2018 - 01.01.2018 -3.1
31.12.2017 - 01.01.2017 7.9
31.12.2016 - 01.01.2016 5.6
31.12.2015 - 01.01.2015 0.3

Past performance is no guide to future performance.
Performance data does not take account of commission or costs charged when units are issued or redeemed. Source: Vontobel Asset Management.