Fund Guide Short Duration Credit Fund March 2017 This document is for investment professionals only and should not be distributed to or relied upon by retail clients. It is only intended for use in jurisdictions where the relevant funds are authorised for distribution or where no such authorisation is required.
About Standard Life Investments Standard Life Investments is a leading asset manager with an expanding global reach. Our wide range of investment solutions is backed by our distinctive Focus on Change investment philosophy, disciplined risk management and shared commitment to a culture of investment excellence. As active managers, we place significant emphasis on rigorous research and a strong collaborative ethos. We constantly think ahead and strive to anticipate change before it happens, ensuring that our clients can look to the future with confidence. As at 31 December 2016, Standard Life Investments managed 277.9 billion on behalf of clients worldwide. Our investment capabilities span equities, fixed income, real estate, private equity, multi-asset solutions, fund-of-funds and absolute return strategies. Headquartered in Edinburgh, Standard Life Investments employs more than 1,700 talented individuals. We maintain a presence in over 20 locations around the world across Europe, North America, Asia and Australia. In addition, we have close relationships with leading domestic players in Asia, including HDFC Asset Management in India and Sumitomo Mitsui Trust Bank in Japan. Our parent, Standard Life plc, was established in 1825. A leading provider of long-term savings and investments, Standard Life floated on the London Stock Exchange in 2006 and is now a FTSE 100-listed company. Standard Life Investments launched as a separate company in 1998 and quickly established a reputation for innovation in pursuit of our clients investment objectives. Our investors rank among some of the world s most sophisticated and high-profile institutions. They include pension plans, banks, mutual funds, insurance companies, fund-of-fund managers, endowments, foundations, charities, official institutions, sovereign wealth funds and government authorities. Contents 1 Introducing the Short Duration Credit Fund 5 What is our investment expertise? 2 What is duration? 5 Find out more 4 How do we invest?
Introducing the Short Duration Credit Fund Following a sustained period of historically low interest rates, investors have grown increasingly concerned about an environment of rising borrowing costs. Typically, rising interest rates have a detrimental impact on bond returns; forcing bond investors to explore strategies that minimise their exposure to interest rate risk. The Short Duration Credit Fund addresses these concerns by offering investors exposure to a portfolio of corporate bonds where interest rate risk is managed to a low level. We reduce interest rate risk through the use of derivative instruments such as futures and interest-rate swaps. This is costeffective and allows us to retain our focus on security selection and searching for the best opportunities in credit markets, regardless of the duration of the underlying bonds. The Fund is managed within our highly experienced fixed income team, which contains over 40 talented investment professionals. The individuals responsible for managing the Short Duration Credit Fund are Daniel McKernan, who has over 20 years investment experience, and Mark Munro, who has nine years investment experience. In managing the Fund, they will target a duration of around two years. Reasons to invest in the Short Duration Credit Fund The Fund offers a degree of protection against the negative effects of rising interest rates. It provides access to an actively managed portfolio of corporate bonds, predominantly investment grade, but with the flexibility to allocate to high yield bonds, where there is the potential of generating higher returns. It is managed by a highly experienced team of over 40 fixed income experts. This Fund may be suitable for investors: seeking to reduce the interest rate risk of their fixed income exposure looking for exposure to an actively managed portfolio of predominantly investment grade corporate bonds. This Fund may not be suitable for investors: who do not wish to take any risk with their capital fixed income is not a risk-free investment who do not wish to invest in a fund that makes use of financial derivatives with an investment time horizon of less than five years. Short Duration Credit Fund 1
What is duration? While bonds are often prized for the stability of their returns relative to equities, it is a mistake to think of them as risk free. While there are a number of risks that can impact the value of a fixed income security, one that affects almost every bond is interest rate risk. A fundamental principle of bond investing is the inverse relationship between interest rates and bond prices; as interest rates fall, bond prices typically rise and vice versa. Intuitively, if a bond carries a coupon of 5% and interest rates fall to 4%, investors will be prepared to pay more for the bond as it offers them a yield in excess of current interest rates. Conversely, should interest rates rise to 6%, investors will be prepared to pay less for the bond in the knowledge they can realise a superior yield from other investments that reflect the new, higher interest rate. Just how much a bond s price will rise or fall in response to a change in interest rates is measured by duration. Duration is a measure of how sensitive the price of a bond is to interest rate movements. To get to grips with duration, investors also need to understand that a bond s duration is not the same as its maturity. Although they can both be measured in years, duration takes into account all the fixed income payments due until a bond matures. Typically, the higher a bond s duration, the longer the investor will be waiting for the bulk of the fixed income payments. And, most importantly, the bond will be more responsive to changes in interest rates. For example, if a bond has a duration of 7.2, it can be expected to fall in price by approximately 7.2% for a 1% rise in interest rates. How to manage duration Depending on the view of the future path of interest rates, the effects of duration may be something an investor intends to harness or to limit. If an investor believes interest rates are going to fall, they could explore opportunities that maximise the resultant upswing in bond prices. However, if they foresee a period of rising rates they might look for strategies that provide some insulation from the negative impact of falling bond prices. One way of managing duration within a portfolio is to tailor the allocation to the underlying bonds to reflect the manager s view. In effect, this might involve holding short duration bonds if interest rates are expected to rise, or long duration bonds if they are expected to fall. However, this approach can incur significant trading costs and can shrink the pool of available bonds a manager has to choose from. Furthermore, in theory, a manager looking to limit their duration exposure may be forced to forego the higher yields available on bonds with a longer duration. An alternative approach to managing duration is to hedge a portfolio s interest rate exposure through the use of derivative contracts, such as futures or interest rate swaps. By holding such instruments alongside an allocation to physical bonds, the portfolio s overall interest rate risk can be altered. Understanding duration and its profound impact on bond prices is critical if investors are to make truly informed decisions regarding their fixed income exposure. 2 Short Duration Credit Fund
The chart below illustrates how this might work. The return from a corporate bond fund has two key market risk component parts. One is the return from the risk-free interest rate. The other component is the credit spread which is extra return over and above the risk free rate and is driven by factors specific to the bond issuer. A duration hedge strategy offsets the return from the risk-free interest rate, leaving only the credit spread (and any outperformance added by active management). What is an interest-rate swap? An interest-rate swap is an agreement between two parties to exchange a stream of interestrate payments for a pre-determined period. Most commonly, one party will agree to make payments to the other based on a fixed interest rate, in return for payments based on a floating (variable) interest rate. Typically, the floating rate of interest will be based on LIBOR (London Inter-Bank Offered Rate), the interest rate at which banks lend to each other. Unlike shares, interest-rate swaps are not traded on an exchange. Instead, the contract is agreed between the two parties involved, known as over-the-counter (OTC) trading. What is a future? Futures allow an investor to take a view on the change in price of an underlying security, including government bonds. It is a contract which states the investor will buy or sell a financial asset or commodity on a date in the future at a fixed price. Duration-hedged portfolio Active outperformance Return Credit spread Active outperformance Risk-free interest rate Duration hedging reduces the benchmark s interest rate risk Credit spread Credit fund Duration-hedged credit fund Short Duration Credit Fund 3
How do we invest? Our Focus on Change philosophy is the bedrock of our investment process. Its application helps us to analyse the key factors driving the market price of an investment and to identify the drivers that the wider market may have missed. We recognise that different factors influence markets at different times in the investment cycle. Our philosophy is not inherently growth or value biased, nor is it momentum driven, giving us the opportunity to outperform throughout the economic cycle. We enforce discipline around the application of our investment philosophy by adhering to a common investment language. This consists of five questions that are applied to all our investment decisions, from security selection and asset allocation to macroeconomic analysis. Analysis What are the drivers? What is changing? What is priced in? Judgement Why will the market change its mind? What is the trigger? Putting the process to work Our process combines bottom-up security analysis with top-down economic and sector insights to help us unearth the most compelling investment opportunities in the corporate bond market. Rigorous research is at the heart of our credit investment process. It incorporates a range of activities. Market analysis we monitor issuance trends and supply/demand dynamics to identify technical factors that might drive bond prices. Company meetings we use meetings to evaluate a company s prospects and assess the strength of its management. Credit research we carry out detailed credit assessments on every company. We also use input from credit ratings agencies where appropriate. Sector review our corporate bond sector specialists identify themes that can make significant changes to the corporate bond environment and outlook. Covenant analysis we assess the strength of the covenant protection on each of the securities in which we invest (such as the financial strength of the issuer, or other features of the bond). We supplement this with external legal expertise. 4 Short Duration Credit Fund
What is our investment expertise? Intellectual capital is our biggest investment, which is why we are committed to recruiting and retaining a team of world-class investment professionals. Our fixed income team contains over 40 dedicated individuals with expertise spanning global government bonds, inflation-linked debt, investment-grade, high-yield bonds and emerging market debt as well as extensive treasury resources. The average investment experience within the team is 15 years. At Standard Life Investments, fund management and research are a combined role. We believe this provides added value in portfolio construction each fund manager is able to draw on the research and expertise of other team members. This gives our fund managers intimate knowledge of the securities in which they invest and maximises accountability. We reject a star fund manager culture and instead promote a collaborative, team-based approach. We believe this to be the most effective way of working as it ensures shared insights and active debate. By challenging ideas and accepted opinions in this way, we can be sure that our decisions are wellinformed and our funds positions well-considered. Meet the managers Daniel McKernan joined Standard Life Investments in 2013 as Head of Sterling Investment Grade Credit. He has responsibility for a number of large credit and aggregate bond mandates. Daniel has over 20 years investment management experience as a fixed income fund manager and prior to joining us worked at Scottish Widows Investment Partnership as Head of European and Sterling Credit. He has also worked at BlackRock, Aegon Asset Management and Norwich Union. Daniel McKernan Head of Sterling Investment Grade Credit Mark Munro Investment Director Credit Mark joined Standard Life Investments in November 2013 from Scottish Widows Investment Partnership (SWIP) where he was an investment manager on the corporate bond team, with responsibility for sterling and euro credit funds. He began his career with SWIP in 2006 as an investment analyst before moving into a fund management role in 2009. Mark graduated from Edinburgh University with a degree in law, and is a Chartered Financial Analyst. Find out more For further details on the Short Duration Credit Fund, please speak to your Standard Life Investments Sales Manager or visit our website. Visit us online standardlifeinvestments.com Short Duration Credit Fund 5
standardlifeinvestments.com The value of an investment in the fund is not guaranteed and can go down as well as up. An investor may get back less than they invested. Past performance is not a guide to the future. This material is for informational purposes only. This should not be relied upon as a forecast, research or investment advice. It does not constitute an offer, or solicitation of an offer, to sell or buy any securities or an endorsement with respect to any investment vehicle. The opinions expressed are those of Standard Life Investments and are subject to change at any time due to changes in market or economic conditions. Standard Life Investments Limited is registered in Scotland (SC123321) at 1 George Street, Edinburgh EH2 2LL. Standard Life Investments Limited is authorised and regulated by the Financial Conduct Authority. Calls may be monitored and/or recorded to protect both you and us and help with our training. www.standardlifeinvestments.com 2017 Standard Life, images reproduced under licence INVBBRO_13_1037_Short_Duration_Credit_Fund_Guide_TCM 0417