By Emma Jenkin and Kieran Quaine
Our managed income portfolio service (MIPS) income plus program has posted solid returns over the last three months – despite a global government bond sell off
The rout in bond markets over the last couple of months has been well publicised with long dated bond prices falling as US interest rates rose triggering a global government bond sell off.
Many bond fund managers have been wrong footed and caught holding long dated fixed rate bonds. According to Yield Report, 32 out of 35 funds posted negative returns for the 3 months to October 2016. November’s result is not due out for another week but we expect returns to be weak as interest rates expectations continue to rise. It will be interesting to read how many fund managers decided to decrease duration* in this particularly weak environment. Against this back drop, MIPS Income Plus Program posted positive returns over the last three months. This outperformance is due to the risk management and positioning of the portfolios by the MIPS portfolio management team.
The November performance figures are tabled below.
MIPS Income Plus November Performance – net of fees
After the last RBA rate cut in August, the MIPS team took profits on 10 August and decreased interest rate exposure, by selling fixed rate bonds and buying floating rate bonds, across all programs. We viewed interest rates as too low across the curve and believed that investors were not being paid enough to hold interest rate risk given the global economic and political uncertainty. While we don’t claim to have predicted Trump’s election win, we did believe, and have highlighted in our quarterly MIPS reports, that the interest rate curve could not rally much further and the risk was to the upside – that is interest rates increasing. This is consistent with the duration* shortening we have been deploying since mid August 2016.
When US interest rates moved upwards around Trump’s election, the Australian government bond yield curve steepened with the chart below showing the size of the moves since the 31 August. MIPS portfolio management had already locked in profits, decreased duration* and accordingly delivered MIPS investors’ strong relative returns over this period.
*Duration is a measure of a portfolio’s sensitivity to movements in interest rates. See the glossary for a definition.
Source: Bloomberg, FIIG Securities
For the period 1 September 2016 to 30 November 2016, the Commonwealth Bond Curve yield and price movements were:
|Commonwealth bond benchmark |
|31/08/2016 ||30/11/2016 ||Quarterly period |
|Maturity date ||Coupon ||Term near ||Yield ||Capital price ||Yield ||Capital price ||Yield change ||Capital price change |
|15 May 2021 ||5.75% ||5 years ||1.55% ||$119.30 ||2.09% ||$115.50 ||0.54% ||-3.19% |
|21 April 2026 ||4.25% ||10 years ||1.88% ||$121.00 ||2.67% ||$113.06 ||0.80% ||-6.57% |
MIPS portfolios are well positioned and while long dated fixed rate bonds don’t offer good value in current markets, we continue to see value in credit – lending to corporates with strong balance sheets, good business models and proven management. The chart below shows the interest rate exposure for the Income Plus Program – which is weighted towards floating rate bonds and near term maturities. Source: FIIG Securities
The majority of the Income Plus portfolio is invested in floating rate and shorter tenor fixed rate bonds. An important dynamic of the high yield bond market is that fixed rate bonds dominate supply. Accordingly, we are targeting high yield bonds issued by companies where we have high conviction on the credit quality and are happy to own bonds with maturities out to five years. While we will likely experience further volatility in interest rates these bonds deliver high accrual yields.
1. Seek best relative value when managed funds try and outperform benchmark
The ability to invest in investment grade and high yield bonds, and shift allocation between the two, is a MIPS advantage that many bond funds don’t share. This allows the portfolio team to invest in the bonds that offer the best relative value rather than track a benchmark. This is demonstrated in the chart and table below, where the relative performance of high yield versus investment grade and government bonds of the same maturity is shown; the government bond yield increased by 0.56%, Lend Lease (IG bond) increased by 0.46% and Capitol Health (high yield) increased the least by 0.16%.
Recall that yield increases translate to decreases in bond prices. Source: FIIG Securities
Source: FIIG Securities
|Security details |
|Yield ||Credit margin |
|Issue ||Rating ||Coupon ||Maturity ||31/08/2016 ||30/11/2016 ||Change ||31/08/2016 ||30/11/2016 ||Change |
|Commonwealth bond ||AAA ||4.50% ||15/04/2020 ||1.41% ||1.95% ||0.54% ||n/a ||n/a ||n/a |
|Lend Lease ||BBB- ||6.00% ||13/05/2020 ||3.65% ||4.07% ||0.42% ||2.24% ||2.12% ||-0.12% |
|Capitol Treasury ||Unrated ||8.25% ||10/05/2020 ||7.58% ||7.74% ||0.16% ||6.17% ||5.79% ||-0.38% |
Importantly, MIPS provides investors transparency as to the bonds they are holding, the duration of their portfolio and the returns being generated.
3. Investments are not pooled
Further, investments are segregated as each investor’s bonds are held beneficially – via an individually managed account (IMA) – and they are not impacted by other investors’ decisions.
The full list of advantages and benefits for investors of investing in bonds via MIPS are outlined in our brochure here. The current example portfolios across the four programs: Conservative Income, Core Income, Income Plus and Inflation Linked can be viewed here.
The MIPS portfolio management team will maintain our short duration* position and await the US presidential inauguration and Trump’s fiscal expenditure plans. We will continue to monitor economic data and await weakness before considering reversing our interest rate strategy.
For further information on MIPS please see our:
If you would like to speak to one of our team about MIPS please call
Mark McCudden in NSW on (02) 9697 8728
Bodo Rose in QLD/NT on (07) 3231 6619
Kate Hurse in VIC/SA/TAS on (03) 8668 8834 Darryl Bruce in WA
on (08) 9421 8502
Glossary *Modified duration
modified duration is a measure of a portfolio’s sensitivity to movements in interest rates, and the percentage change in a bond's price for a 1.00 percent change in the whole yield curve. For example, a portfolio with a three year duration would lose 3% if that interest rate curve moved up by 1% across the whole curve. Conversely, a 1% downward move across the curve would result in a 3% gain. In reality, the curve rarely moves in parallel and it will typically move by different amounts for different tenors. This is what we have seen recently with the long end of the curve (5+ years) moving by more than the shorter end, less than five years.