Benjamin von Haase
Head of Risk Control & Multi Asset
Risk control for duration and credit risks with Finreon Fixed Income Risk Control®
Systematic risk premiums with reduced substance losses.
The Finreon Fixed Income Indicator measures the interest rate and credit risk of bonds on a daily basis using a variety of factors. Based on this, the duration and credit risk of the Finreon Fixed Income Risk Control® solutions are managed.
By measuring and managing duration and credit risk, investors benefit from long-term risk premiums on bonds while controlling risk against asset losses.
Finreon Fixed Income Risk Control® is an optimal substitute for core bond investments with a long track record and offers additional protection against large losses in value in the event of a rapid rise in interest rates or an increase in credit spreads.
The current low interest rate environment leads to a scarcity of investment opportunities After 30 years of falling interest rates, yields are near historical lows – investment opportunities are scarce. But as alternatives are limited, bond quotas remain high with most investors.
Risk premia for interest rate and credit risk
Academic studies reveal a systematic risk premium for interest rate and credit risk, as both risks are rewarded in the long-term. A renunciation of these risks means repeatedly lower returns for investors (carry & roll-down effect for duration and credit risk) due to forgone risk premia.
With an investment in long-dated corporate bonds, investors have been able to achieve a return of 4.28% p.a. (250% cumulative) over the past thirty years. (250% cumulative) higher return than with an investment in short-dated government bonds.
Drawdowns in interest rate markets
Historically, periods of rapid rise in interest rates have been rare. Over the last thirty years only three such occurrences lead to negative annual returns. Nonetheless, in the current low yield environment bonds are vulnerable to an increase in yields and therefore enlarged drawdowns.
Drawdowns in credit markets
Crises in credit markets have increased in frequency and significance in recent years. Especially in times of a systemic crisis (Financial crisis 2008, European crisis 2011) corporate bonds are subject to substantial price corrections and rising credit spreads.
How can regimes of high interest rate and credit risk be identified? The Fixed Income Risk Indicator (FIRI), which has been exclusively developed by Finreon AG, is a combination of two risk engines and allows to identify interest rate and credit risk regimes in the bond market.
Interest Rate Indicator (IRI)
The «Interest Rate Indicator (IRI)» is based on a multitude of daily measures. The result – the current interest rate regime – is shown as a risk signal: Red for rising rates, yellow for stable rates and green for falling rates.
Credit Risk Indicator (CRI)
The «Credit Risk Indicator (CRI)» is based on a multitude of daily measures as well. The result – the current credit risk regime – is shown as a risk signal: Red for high credit risk, yellow for normal credit risk and green for low credit risk.
Finreon Fixed Income Risk Control® solutions manage duration and credit exposure dynamically and systematically through the Fixed Income Risk Indicator (FIRI). This way investors can profit from risk premia on interest rate and credit risk, while at the same time controlling for drawdowns. Thereby, Finreon Fixed Income Risk Control® is ideally suited to optimise the risk/return profile of fixed income securities and circumvent the scarcity of investment opportunities in the current low yield environment. With a systematic risk control, bonds become «investable» again.
Finreon Fixed Income Risk Control® Funds are 100% physically invested bond funds (BVV 2) under Swiss law (no stamp on subscription or redemption). Derivatives are used exclusively for risk hedging. Funds are available on USD-denominated bonds as well as EUR-denominated bonds and are suitable as an optimal substitute for core investments in foreign currency bonds (CHF-hedged).
Mandates – The Finreon Fixed Income Risk Control® strategy can be accessed by qualified investors through investment mandates. Please contact us for further information about our mandate solutions.