Morningstar has two alternative fixed income categories: Multi-sector bond and Non-traditional bond. Multi-sector bonds have a broad mandate where a strategy can go into high yield, foreign developed, emerging debt, etc. Non-traditional is even broader. It includes the previous, but it can also do things like derivatives, interest rate swaps, and credit default swaps. Also, Multi-sector tends to be more strategically allocated whereas Non-traditional tends to be more tactically allocated.
Against the category averages for Multi-sector Bond and Non-traditional Bond, the DRS performs quite well. In terms of absolute return, DRS outperforms traditional and alternative fixed income by a wide margin. The volatility of the DRS is certainly higher than any of the bond options, but the DRS’s superior Sharpe ratio of 0.67 indicates the additional risk was more than adequately rewarded with additional return.
The point of this exercise, however, is to see how the DRS might perform in a capital preservation role alongside the alternative fixed income options. The betas of the DRS and the alternative fixed incomes to the S&P 500 index are all low, and the correlation of the DRS to the S&P 500 is actually lower than the alternative fixed categories. The quarterly down market capture of the DRS is almost identical to that of the Non-traditional bond category, and the maximum drawdowns are similar. Based on these results, one can make the case that the DRS could be utilized as a fixed income alternative.
While the above table indicates that traditional investment grade bonds represented by the Barclays U.S. Aggregate are the least correlated to the S&P 500 and offer the best downside protection, that might not always be the case going forward. It is questionable whether investors are truly aware of the magnitude of the risks embedded in traditional investment-grade bonds.