European fixed interest fund managers look to Ucits III

Falling volatility and tight credit spreads have forced fund managers in the European fixed interest sector to look to the new freedoms offered by Ucits III to generate returns, says Standard & Poor.

“Managers of traditional retail fixed income funds have greater need for derivatives - and appear to be using them more actively at the moment – than traditional equity managers,” said Kate Hollis, the analyst who wrote the report. “Most fixed-income managers have decided to use derivatives, particularly interest-rate and credit default swaps, for more efficient portfolio management but without changing funds' basic objectives. Some managers have completed the necessary risk management and back office preparations and are using swaps now, and nearly all will be using them by the end of Q1 2007.”

Allianz Group – through its subsidiaries PIMCO and dit – has been at the forefront of adapting to the new opportunities. The company is a significant presence in the European fixed interest sector and has nine funds in the review, including four of the six AAA rated funds. “These funds draw on the PIMCO fixed interest teams for input,” said Hollis, “which has been quick to recognise the potential in Ucits III and are implementing a significant number of ideas using swaps and other derivatives.”

Augmenting management and research teams to deal with the new options has been a key to using them successfully. DWS, which has eight funds in the survey, strengthened its risk management teams in 2005 to deal with the increased use of derivatives. “DWS appointed a derivatives specialist at the beginning of this year, and plans on more hires in 2007. Their managers have been using this resource sensibly and their funds are all solid AAs.”

Other fund managers in the European fixed income sector that have made good use of Ucits III provisions include Schroders, Goldman Sachs and Union Investments. Notably slower to implement have been M&G and T. Rowe Price.

The review covers 84 funds, of which 36 achieved an A rating, 34 attained AA, six AAA. Three are Not Rated and five funds were Under Review at the time of the report following late-breaking changes to fund management and investment processes that will need to be assessed before the funds can be given a rating. Ratings remained relatively static within the sector, with just one upgrade this year – Fortis L Fund Bond Long Euro moving from Not Rated to an A rating – and six downgrades, including three from Schroders. Team and process issues were behind the ratings changes this year, which were relatively few given the number of funds reviewed.

“This year, there was no event-driven test to really differentiate management approaches,” said Hollis. “Team turnover was high again this year, however. A few London-managed funds had some team change, mostly as a result of corporate actions, but there was considerable turnover in Paris and Frankfurt, some at a high level.” A number were put Under Review as a result, while some AXA and Fortis funds have had their ratings re-established, having been Under Review earlier in the year. “Few other funds have changed their ratings this year as their teams and processes have remained consistent,” added Hollis.

Standard & Poor’s latest review of the sector now available at funds-sp.com.