Bond investors

Bond investors warned not to overlook

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While most fixed income investors recognise the need to take a more flexible approach to finding return in a threatening interest rate environment, T. Rowe Price head of international fixed income Arif Husain believes that most investors are overlooking fixed income’s role in protecting portfolios from equity market shocks.

With record low interest rates and the 30-year bond market bull rally coming to a close, returns in fixed income markets are becoming increasingly hard to find. That is why many fund managers have successfully marketed so-called unconstrained bond funds which do away with traditional benchmarks and are instead free to use any market, any security, and any means to find value.

But while using currency markets, negative duration, derivatives and so forth to achieve higher returns is all very well, it only deals with one part of the fixed income story.

Speaking to Financial Standard, Husain said: “The unconstrained world is a garden of both good and evil. The majority of folk out there have taken that broader flexibility and used it to try and find return. To borrow an American expression, they go on offense.”

“We’re using all that extra flexibility to try and find new ways to go on defence.”

Husain wants his bond fund, the T. Rowe Price Dynamic Global Bond Fund, to behave like bond funds used to behave – to be a store of value, or even post positive returns when equity markets fall.

“We want to provide a bit more liquidity, a bit more simplicity and a bit more transparency. We don’t want to use all the funky derivative structures that are out there,” Husain added.

“I used to be a derivatives trader so I know there’s nothing wrong with them, but I don’t think every client wants them in their portfolio.”

What Husain and his team look for when buying bond markets is three characteristics: low volatility; little probability of what the bond expert calls ‘jump risk’, or a regime change in volatility; and a relatively steep yield curve.

Regionally that approach has seen the fund take a relatively negative view on the US, where Husain believes a rate hike will come sooner than most investors expect; a very positive view in Asia, especially in lower volatility countries like South Korea; and a negative view on Europe, where the outcome from Greece’s debt crisis remains uncertain.

The strategy is unique in that it was built for the Australian market. Unusually, it launched here first (in February 2014) and was then released to the US market later. It is only just being made available to European investors now.

The fund has not had its defensive characteristics fully tested yet as the equity market has performed well in the 18 months it has been running but Husain did note its rolling correlation with equities over that period has been close to zero, if not a little bit negative.

Further, in short, sharp periods where the equity market has faced drawdowns, the fund has done exactly what it’s aimed to do – either staying stable or posting positive returns.

“The coming months up until and a little bit after the Fed rate hike are going to be a real testing ground for these types of strategies. When we see negative returns across traditional bond funds, you’ll want to see these strategies at least at zero and hopefully positive,” Husain concluded.

[via Financial Standard]

Future of Financial Advice

FoFA among top 20 global regulatory nightmares

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The Future of Financial Advice (FoFA) reform is one of the 20 most challenging pieces of regulation globally, according to a survey of 600 compliance professionals across the world.

The ‘Cost of compliance 2015’ report by Thomson Reuters asked compliance professionals from financial services firms all over the world to name the regulation that poses the greatest challenge for the coming year.

FoFA was listed along major regulatory changes such as the Basel III rules that will require banks to hold more capital, or the Volcker Rule in the United States that limits the bank’s relationships with hedge funds and private equity funds to prevent them from making speculative investments.

The US Dodd-Frank Act, a major regulatory reform following the GFC that has been compared to FoFA, is also listed among the most difficult regulatory challenges.

However, the UK’s equivalent piece of legislation, the Retail Distribution Review (RDR) was not part of the list.

The research also found that compliance officers are experiencing “regulatory fatigue and overload in the face of snowballing regulations.”

As many as 70% of the firms are expecting regulators to publish “more” regulatory information in the next year and 28% expect that the increase will be “significantly more.”

More than a third of the firms surveyed spend at least a whole day every week tracking and analysing regulatory change.

“Global regulatory change is creating the biggest challenge due to inconsistency, overlap and short time frames,” the report said.

“Understanding regulators’ expectations and requirements and being able to interpret and apply them is as great a challenge as keeping abreast of the changes.”

As a consequence, regulatory risk and costs are both expected to rise in 2015, with 68% expecting the compliance budget to be slightly or significantly higher than today in 12 months’ time.

[via Financial Standard]

Sydney Apartment

Beware over paying for assets

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Sydney_Apartment1The Australian economy is facing a number of head wins as we enter 2015 and therefore is expected to grow below long term averages.  Whilst consumer spending is improving and residential construction and prices are rising, consumer confidence remains weak. Business confidence and investment is also weak.

Australian bond yields have fallen to historical lows. The RBA cut the cash rate by 25 basis points to 2.25% in February concluding that growth is continuing at a below trend pace, with domestic demand growth overall point weak.  The financial markets are expecting the RBA to make further cuts to interest rates in the coming months.

As a result, investors seeking yield will continue to reallocate from cash and term deposits into higher yielding assets, including real estate.  Demand for both residential and non-residential assets should continue and competition for both income generating and development assets will remain high.

According to the PCA/IPD Property Index, non-residential property has generated a total annual return of 10.6% in 2014, and Folkestone expects a similar return in 2015 as investor demand continues to underpin capital values.

Investors need to be cognisant that they do not overpay for assets in a market being driven by capital hunting for yield.  The market runs the risk that if the disconnect between capital market and real estate market fundamentals widens, the price some investors pay for assets may overshoot the underlying fundamentals.

In the residential sector, the housing boom has not been uniform across Australia.  Whilst Sydney has been the stand out performer with prices up 13% in the year to January 2015, price growth across the rest of Australia’s major cities was between -0.3% in Canberra and 7.0% in Melbourne.

There is no doubt the Sydney median house price has risen to levels that make it difficult for first home buyers to enter the market, but we should remember that the average annual growth in Sydney house prices has only risen by an average of 4.5% per annum over the past 10 years.  Sydney is now paying for a gross undersupply of accommodation as a result of poor government planning and high government levies which have restricted the release of land and pushed up land prices.

Low interest rates are certainly driving the investor market, with investors taking over owner occupiers as the largest borrowers of finance in the December quarter.  We expect investors will continue to invest in the residential sector in 2015 but in doing so, they need to ensure that they do their homework.  There are certain markets such as inner Melbourne and inner Brisbane where an oversupply is looming.

The recent APRA announcement around investment lending may go some way to restricting the availability of finance to investors.  Overall we are expecting another solid year of housing market conditions and further capital gains, albeit at a more sustainable rate than we have seen over 2014.

 — via the FINANCIAL STANDARD, Mar 30

Economic growth to slow significantly

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E071D108048541A4A4924248176C9FF9.ashxThe Intergenerational Report (IGR) has projected that the growth rate of the economy over the next 40 years will be significantly lower than the last 40.

In introducing the report Treasurer Joe Hockey said:

“it is fantastic that Australians are living longer and healthier lives but we need to address these demographic changes. If we don’t do something, we risk reducing our available workforce, impacting negatively on growth and prosperity, and our income will come under increasing pressure.”

Released today, the report projected average economic growth of 2.8% per annum over the next 40 years with annual growth per person of 1.5%. This would see the annual income of the average Australian rise from $66,400 today to $117,300 by 2055.

This growth rate is expected to be slower than the 3.15% per annum, or 1.7% per person, achieved over the past 40 years due to an ageing population and gradual decline in the participation rate.

“To achieve this level of growth going forward, we must take steps to build jobs and opportunity. We also need to make choices today to prepare for the future”, the report said.

“We have a responsibility to plan and budget not only for today, but that tomorrow.  But we are currently living beyond our means.”

The Australian government’s spending over $110 million per day more than it collects and his borrowing to meet the shortfall resulting in $40 million being spent per day on interest repayments.

However, the report said that if the government’s policies are fully implemented it projects the underlying ash balance to improve to a surplus of 1.4% of GDP in 2039 – 40, and then moderate to a surplus of around 0.5% of GDP in 2054 – 55. Net debt is projected to be fully paid off by around 2031 – 32.

The government is open to alternative measures to bring the budget back to surplus. The policies proposed by the government, if fully implemented, will improve Australia’s capacity to respond to the challenges and opportunities outlined in the Intergenerational Report.

Male life expectancy is projected to increase from 91.5 years today  to 95.1 years in 2055.  The number of Australians aged 65 and over is projected to more than double by 2055 compared with today.

The number of people aged between 15 and 64 for every person aged 65 and over has fallen from 7.3 people in 1975 to an estimated 4.5 people today. By 2055, this is projected to nearly halve again to 2.7 people.

 

 — Mark Smith via the FINANCIAL STANDARD

AMP posts 32% increase in profit

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Platinum backs Internet stocks and Asian infrastructure

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fin_std_logoStar manager Kerr Neilson’s listed investment company Platinum Capital is backing out-of-favour big-name US technology companies as well as infrastructure plays in China and India.

In a quarterly update to shareholders the billionaire investor said he was surprised that Internet stocks like Oracle, Cisco and Intel had become neglected by the wider market.

“Each has its own threats regarding substitution but, on careful analysis, these companies revealed unusually following business characteristics,” he said.

“While it may seem improbable that well-known brands like these should be misunderstood, we can mount a strong argument why they should both grow and remain decidedly more profitable than the typical company in the S & P 500 index.”

The top-performing manager has also picked up new infrastructure focused investments in the largest of the emerging market economies India and China.

“The companies themselves are fine, but out-of-favour because they are seen as dull. As you would have read in these reports on countless occasions, dull is delightful if the price is right. Here we can buy electricity generating or gas transmission capacity for little more than book value with the prospect of significant growth in demand reaching out into the distant future,” Neilson said.

“The portfolio has been progressively tilting towards Asia. We can still find shares to buy in the West, but within the reform-minded countries of Asia there are bargains.”

 

Mark Smith
27 January 2015 Article
via the FINANCIAL STANDARD

Reasons to cheer amid gloomy predictions

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fin_std_logoDespite the gloomy outlook, Australian Investors have reasons to feel optimistic. With the domestic housing boom reaching its peak, construction is set to see “a record year,” Bank of America Merrill Lynch chief economist Saul Eslake told the Financial Standard

Perpetual head of market research Matt Sherwood said that “companies exposed to housing and infrastructure operating in the east will do well.”

According to financial services Council chief economist James Bond, the retail sector will be the next to benefit from construction growth, as people first by a house, and then they buy the furniture white goods to put in it. Falling oil prices are also likely to have a positive impact on the sector.

However, Australia will go through what Bond calls “the two-speed economy in reverse.”  This means that “Western Australia and Queensland will be heavily affected by the slow of the mining boom”, while New South Wales and Victoria are expected to do better thanks to their large manufacture sectors and infrastructure investment.  In NSW, infrastructure construction “seems to be going fast enough that it will have an impact on the economy this year.”

Eslake made a distinction between gross domestic product (GDP) and gross domestic income (GDI), an indicator that measures income and purchasing power.  In the September quarter, GDP increased by 0.3%, but GDI fell by 0.4%, according to the Australian Bureau of statistics.  “This is an important reason for the ongoing weakness in household income and consumer spending,” Eslake said, and concluded that “domestically-oriented companies will struggle.” Lower oil prices “will provide some support, but we are looking at a fairly sluggish year.”

While Australia’s financial institutions have benefited from investors search for yield, Sherwood predicted that “they will underperform the rest of the market, but will deliver attractive yield in the low return environment.”

Looking abroad will be another key trend in 2015.  Lower valuations in the European Union and Japan are likely to attract long-term focused investors, while “any stock exposed to the United States economy will do well,” Sherwood added.

Unhedged portfolios exposed to global assets can benefit from falling Australian dollar, which means “this is a good time to rebalance get more exposure to industries such as healthcare, IT and biotechnology, which are not that strong in Australia.”

PM Capital Chief Investment officer Paul Moore considered stellar returns in global equity funds last year unlikely to be repeated in 2015, but limited opportunities in other asset classes make global equities look like a good option.

“The options are to have some cash around so if we do get a little disruption it can be put to work in the equity market or own off-shore businesses, where we can continue to get 6% – 8% return. If you add the currency in there we might end up into below double-digit which would be a solid outcome.”

– Laura Millan
27 January 2015 Article
via the FINANCIAL STANDARD