With interest rates slashed to near zero (and in some cases negative) in Australia and across most of the developed world, investors face an increasingly difficult challenge to generate investment returns. Many have had to shift their expectations, or in some cases move to riskier investments. We take a look at how our investment team searches for the best opportunities to include in our fixed income portfolio.
Low yields on offer
Bond yields and interest rates have been trending lower for nearly 40 years after peaking in the high teens in the early 1980s. Since the 2008 financial crisis, interest rates across most developed economies have been anchored near zero, or in some cases negative, and Australia has recently joined in as we deal with the fallout from the pandemic.
High interest savings accounts, term deposits and government bonds in Australia currently offer negative real yields (real yields are adjusted for the effects of inflation). As a result, investors have been forced to either shift their income expectations and swallow a loss in purchasing power over time, or look to alternative sources of yield. This generally includes taking on more risk or giving up liquidity. We are concerned that many people in the search for a higher yield do not fully understand the risks associated with the investments they choose, this can lead to the loss of capital.
Despite the low yields on offer, as at the end of June 2021, our Fixed Interest Separately Managed Account (SMA) has managed a decent return of 4.88% per annum since inception in January 2018. By comparison, the Australian bond index, as measured by the Bloomberg AusBond Composite, returned 3.38% p.a. over that period, whilst rolling one-year term deposits would likely have returned under 1.5% p.a..
Returns have primarily been driven by yield, though capital appreciation has also had a hand in the strong performance relative to the benchmark of floating cash rate plus 0.5% p.a.
*All figures are total returns gross of fees and indicative of the model performance only. Actual performance from a live portfolio may differ due to rounding, brokerage and other factors. Trades are taken at close of date prices on the date of change, which may differ from prices obtained by actual trades.
**Benchmark is the Bloomberg AusBond Bank 0+Y Total Return AUD + 0.5% p.a.
† Inception date is 1st Jan 2018.
A brief look at the PWG Diversified Fixed Income SMA portfolio
As the charts below show, the SMA is a diversified portfolio with the ability to invest across the fixed income spectrum, from government bonds to direct lending exposures and listed hybrids. We manage positions and allocations actively in the effort to find the opportunities that provide the best risk-adjusted returns available with the philosophy of focussing on capital preservation.
Currently, our portfolio has an approximate gross yield of 3.5% p.a., primarily driven by exposures in direct lending, some of which provide over 6% p.a. in yield. We have maintained a bias for such exposures since the inception of the SMA, preferring to focus on quality managers with great long-term track records. As a result, our direct lending exposures experienced no defaults, impairments or capital losses to date. Despite mark-to-market price volatility during the drawdowns last year, these exposures continued to consistently pay regular attractive yields to our investors.
Another great source of returns has been our active management in listed hybrids as we ‘roll’ our existing exposures into new, longer-dated issuances that are sometimes issued at more attractive margins than those available on the market. We assess each new offer relative to the market and maintain strict discipline with regards to our liquidity and quality assessments. Over the past six months, we have participated in two new issuances, both of which came to market above the issue price and continue to do so. We continue to expect several further issuances over the next year which will continue to provide opportunities for our active approach to take advantage of.
If your client would like further information on the PWG Diversified Fixed Income SMA or other investment opportunities, please contact an advisor.
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This month’s perspective highlights that market sentiment on all asset classes is constantly changing. At Partners Wealth Group we constantly monitor investments and client's portfolios, and it is important for us to quickly recognise any threats, to preserve investment capital or to identify early investment opportunities to maximise any return advantages.
If this article has raised questions regarding opportunites for your clients, please contact your Partners Wealth Group advisor directly or on 1800 333 143.
This article contains information that is general in nature. It does not constitute financial product advice and should not be relied upon to determine or make investment decisions. It does not take into account the objectives, financial situation or needs of any particular person. We recommend investors seek professional advice before making a decision to invest. PRPIA Pty Ltd (ABN: 17 140 105 077), trading as Partners Wealth Group is an authorised representative and credit representative of Charter Financial Planning Limited, Australian Financial Services Licensee and Australian Credit Licensee.