Our Managed Income Portfolio Services (MIPS) three funds – Income Plus, Core Income and Conservative Income, continue to rank in the top 10 managed bond bonds, with Income Plus ranking in the top five. Here Portfolio Manager, Kieran Quaine outlines the quarterly results and the team’s strategies.
MIPs returns ranked very highly against peers. All MIPS Investment Programs performed in the top 10 during the quarter, and Income Plus in the top five, compared to circa 50 competitor bond funds as measured by the ‘Yield Report’*.
Source: MIPS September quarterly report
Clearly the MIPS Portfolio Management Team (PMT) strategy to invest short and in high accrual corporate assets, was correct. Even though the strategy set proved correct, getting accounts exposed to the same assets that resided within our example portfolios proved difficult. We retain the same exposure preference and will continue to build client portfolios to match preferred exposure as and when supply is available - at the right prices.
Key economic observations
- The US Fed tightens monetary policy and is “a long way from neutral”
- Global interest rates are on the rise
- Australia’s probability of a 2019 Federal Labor Government increases
- Australian banks tighten lending standards and residential property prices suffer
- The RBA holds monetary policy firm at 1.50% and the AUD declines
The key global theme is that interest rates are rising, albeit slowly. They are rising in Australia, but at a slower pace than the rest of the globe. In such an environment, staying short on the yield curve will avert capital loss and maintain performance.
It would appear the US economy is experiencing near economic nirvana – full employment, improving per unit labor productivity and subsequently non inflationary growth. Yet the economic bears are already pondering the timing of the reverse in the economic cycle, proposing that the aggressive monetary policy stance of the US Fed will eventually stall growth. Only time will tell.
The MIPS team needs to manage according to the environment, noting that as the momentum for the rise in rates dissipates we will have investors appropriately positioned to take advantage of higher interest rates at the right time.
This economic and policy environment is, in our opinion, conducive to a steepening of the Australian yield curve. Short rates will remain low, pinned down by the monetary policy anchor, yet longer rates will rise, as investor capital is attracted to higher yielding bonds issued by other sovereigns, and Australian long dated bonds will therefore likely decline in value as yields rise to compete.
Key (net) per annum yield metrics per $500,000 investment (model portfolio)
Source: MIPS September quarterly report
Key contributors to September quarter end returns
- Consistent with our medium term strategy, all investment programs retained a “short duration” and “long (short dated) credit exposure” position during the quarter. This is known as a ‘short credit spread duration” strategy.
- The predominant credit exposure strategy, especially in the non investment grade (NIG) sector, is to hold short dated credit with a high accrual advantages.
- The widening of credit margins experienced in the June quarter was short-lived, whether for major and minor bank FRN spreads, investment grade (IG) or NIG corporates, or IG or NIG Residential Mortgaged Backed Securities (RMBS).
Credit margins in RMBS land have not changed markedly, and we expect our strategy of slow accumulation is still best, especially given the pressure upon underlying (residential property) collateral.
The RMBS sector is expected to outperform singular name 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 IG rated outcomes and subordination support are positives.
Relatively, the RMBS sector still holds appeal.
* See yieldreport.com.au. Yield Report provides an independent analysis of the interest rate markets and interest rate securities. Access to the site free.
You can view the September 2018 quarterly report here.