Altius Asset Management has warned there is a risk of losing a generation of fixed interest investors who may become disillusioned with returns.
“With yields at historically low levels, investors holding fixed interest portfolios that reflect the benchmark rather than being actively managed do run the risk of incurring capital losses.
“However, it’s important for long term investors to have a well-diversified portfolio that holds fixed interest because having a duration exposure is the best way to cushion portfolio losses when there is a downturn in equity markets, typically driven by a poor economic outlook,” says Bill Bovingdon, chief investment officer at Altius.
“Whether investors believe the global economy will recover or will deteriorate further, having some fixed income exposure to provide duration is important to maintain a balanced portfolio.
“In either economic environment, active fixed interest fund managers can add value with well-constructed strategies that also help protect capital.
“For example, while duration is your friend in poor economic environments, it can quickly turn into a foe when the economy improves if the bond investments are not well-managed.
“In a rising rate environment, this could include investing in short-dated bonds which have a lower duration and are therefore less sensitive to interest rate changes.
“Short-dated corporate bonds that have a yield above the cash rate benefit from capital gains (in addition to accrued income) as the yield falls toward the cash rate over the life of the security.
“Other strategies include investing in floating rate notes (FRNs), as they pay a fixed margin above an agreed level such as the bank bill swap rate and avoid the downside of rising interest rates by giving up some of the potential upside if rates fall. In a rising interest rate environment, spread compression can lead to capital gains in FRNs. Using interest rate swaps to swap fixed rates for floating rates can also benefit returns.”
Mr Bovingdon said unfortunately traditionally managed fixed income portfolios and index funds do not provide this flexibility for investors.
“There is a tendency for investors to lump all fixed income funds into the one bucket, yet active managers that have developed processes and strategies – such as the ability to switch into credit strategies and floating rate notes – can add real value.”
He added Altius believes that domestically a two-speed economy remains and the transition is unlikely to be smooth or perfectly timed.
“With inflation tracking at the mid-point of the inflation objective, the Reserve Bank of Australia (RBA) is able to provide further stimulus if required.
“Overall Altius believes the short end of the Australian yield curve will be underpinned by RBA easing, while upside surprises on global growth will put pressure on longer dated bonds.
“China and the US, in general terms, have seen improved economic performance year on year since 2010. While data releases for the second quarter of 2013 have mostly been weak, it is likely this is a temporary soft patch due to the US sequestration and seasonal factors (second quarter data has been weak for the past three years).
“Such scenarios mean it is important to have fixed income exposure in a broader portfolio context to act as a counter to equity markets. In rising rate environments fixed income does not need to be the enemy,” Mr Bovingdon said.
Altius Asset Management is a boutique fixed interest asset management business, formed through a joint venture with Australian Unity Investments in 2011.
The Australian Unity Altius Bond Fund adopts a dual benchmark approach, seeking to outperform both the cash and bond market. The aim is to align the fund’s performance profile with investors’ expectations of positive returns over all market cycles. The Australian Unity Altius Bond Fund allows investors to effectively outsource the asset allocation between cash-like investments and fixed income.
For more information please contact:
Bill Bovingdon – Phone: 02 9112 4701
3 June 2013