Monday 23 April 2018 by Kieran Quaine At FIIG

MIPS 1Q18 results - a change of tack

Kieran Quaine, MIPS Portfolio Manager summaries first quarter performance and a revised strategy

sailstorm

The US economy continues to drive global growth and the US Federal Reserve is tightening monetary policy aggressively. However, tepid domestic growth is not delivering enough employment gains for the Reserve Bank of Australia to move as quickly.

At the tail end of the quarter, the cost of short dated funds in the Australian market climbed significantly. Three month (90 day) bank bill rates, being where major banks can borrow short term money, have climbed in the order of 0.25%. Banks are now paying close to 2.10%, or 0.60% above official cash, a significant premium not seen for a very long time.

But of additional importance, this increase in the short term base interest rates will increase the running yield of floating rate notes (FRN) and reduce the gap between the running yield of FRN’s and longer dated (steeper curve) fixed rate assets. That steeper curve, in this potentially ‘lower for (slightly) longer’ monetary policy environment, will encourage investment longer on the yield curve, hence a lengthening of duration.

Quarter on Quarter change in the Australian Interest Rate Swap yield curve


Source: Bloomberg, FIIG Securities
Figure 1

The team believe the Residential Mortgage Backed Securities (RMBS) sector will outperform corporate credit. RMBS margins have lagged the compression in credit that corporates lending in senior and subordinate structural form have benefited from. Additionally, residential mortgage lending standards have improved. Pool diversity and loan to valuation ratios of course need review for credit approval to meet MIPS investment criteria, but standardisation of this process to deliver investment grade rated outcomes and subordination support are positives.

Thus we’ve sold down investment grade credit and have made substantial allocations to Residential Mortgage Backed Securities.

MIPS Strategy for all programs

1.   The team will be extending duration for the first time since August 2016
2.   Decreased exposure to investment grade debt, especially subordinated debt and increase exposure to residential mortgage backed securities

Key themes:

  • The US Federal Reserve tightens monetary policy to 1.625%
  • The RBA maintains monetary policy at a record low of 1.50%
  • Bank wholesale funding costs are on the rise
  • Base yield curve volatility is low currently and credit margins appear to have troughed

Program NET returns for the quarter ended 31 March 2018


Source: FIIG Securities

The MIPS Investment Programs of Conservative Income, Core Income, Income Plus and the various Customised Mandates that include the Bank Bond Programs, invest among a universe of approximately 70 assets.

For the full report, please click here.

Please contact your local dealer or call 1800 01 01 81 if you’d like to learn more regarding any of the programs.


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