As part of our monthly series of spotlighting one of our Liquid Alternatives preferred holdings, I would like to provide some color on the Pioneer Dynamic Credit Fund (symbol: RCRAX).
On the surface, RCRAX may look like any other bond fund and one may ask what it’s doing in our alternative model line-up. Well, it’s anything like a traditional bond fund once you take a look under the hood. RCRAX is a non-traditional fund utilizing fixed income securities in alternative ways such as shorting or using derivatives, default swaps, event linked bonds, etc. As such, it’s basically an absolute return fund using fixed income vehicles.
Let’s review a little about the credit markets. Income is now a scarce commodity. As a result, investors are forced to take on more risk in order to achieve the same levels of income that they have experienced in the past. Unfortunately, fixed income investors face a more volatile and uncertain investment environment than the last few decades. However, volatility can create opportunities, and a flexible investment approach may be able to capitalize upon these opportunities.
Credit can provide strong returns, but one must tread carefully as downturns in the credit cycle can cause large a drawdown, the peak-to-trough decline during a specific record period of an investment. The traditional response to a credit downturn is to increase credit quality and/or add Government Bonds. The former can hurt the portfolio due to transaction costs as market liquidity deteriorates. The later may be less effective in the future given how compressed the yield curve is. We think a more effective risk management strategy for an all-credit portfolio lies in what Pioneer calls their multi-layered hedging approach. This multi-layered hedging strategy seeks to buffer volatility and provide a measure of protection from extreme market dislocations. And as our clients know, protection is one of our number one goals at DWM.
Put it all together and you have a multi-sector credit portfolio designed to adjust allocations in order to take advantage of opportunities based on valuations, volatility, dislocations and market timing across credit markets. Portfolio construction, allocation, and security selection are driven by an integrated quantitative and fundamental research framework. We get excited about this fund because it can and does short different parts of the bond market, which means it can take advantage of rising rates! It also plays in areas that the standard traditional bond funds don’t, like convertible securities, floating rate securities, and currencies.
This approach has landed RCRAX in the top quartile of the non-traditional bond category as determined by Morningstar since its inception in 2011. And of course this approach has given us reason to give it a seat in our Liquid Alternative model.
Again, alternatives provide an additional asset class that can produce new sources of returns with lower correlation and reduced volatility. We expect volatility and returns for the alternative portion of one’s portfolio to be somewhere between what you would expect of stocks and bonds, with an extra bonus emphasis on downside protection. We continue to watch this exciting area of investment management for continued opportunities and use this forum as an educational tool.
Please don’t hesitate to reach out to the DWM team if you have a particular question on liquid alternatives and/or just want to say ‘Hi’!