By Emma Jenkin and Kieran Quaine
Read about Kieran’s views on structuring the three Managed Income Portfolio Service options
We are excited to introduce Kieran Quaine as the Head of MIPS with responsibility for all investment decisions. Kieran is a seasoned fixed income expert with over thirty years’ experience investing and managing money. Kieran has been at FIIG for over seven years, most recently as Head of Syndicate and was previously a senior portfolio manager at AMP. Click here to view Kieran's profile.
The Managed Income Portfolio Service (MIPS) has had a big six months since launch. We are pleased to announce that we have over $100m of commitments in MIPS across the Core Income, Income Plus, Inflation Linked and Customised Programs.
Below is an excerpt from our December 2015 quarterly report which outlines some of the portfolio management teams’ thinking. Strategies are being constantly reassessed in light of market conditions.
An excerpt of the MIPS Quarterly Report: Investment strategy
Our current strategy favours investing in medium tenor subordinated bonds issued by banks that are rated investment grade. The aim is to maintain credit exposure but decrease individual holdings sizes by adding more issuers to the portfolio in lower parcel volumes. The team continues to search the market for strong performing credits, seeking to rebalance portfolios to take advantage of opportunities driven by price movements in volatile market conditions.
Specific credit highlights include:
- Upgrade of Qantas from sub investment grade to investment grade
- Participation in the primary issue of NEXT DC: an unrated bond originated by NAB
- Retained Payce exposure given positive assessment of high yield to first call date
- Participated in PMP refinancing as the terms were advantageous for existing bond holders
- Accessing ANZ, BOQ, Bendigo and Adelaide and Members Equity subordinated bonds
Inflation and inflation linked bond outlook
Lower global growth and falling commodity prices continue to put downward pressure on prices consumers pay for all goods. The markets expectation for longer term inflation still tracks in the RBA target range of 2% to 3% with the expectation of 2.36% over 20 years, but for the short to medium term (5 years) the expectation is just below that range at 1.90%. The table below shows the markets’ inflation expectation at the end of December. This is calculated by taking the difference between the Australian government nominal bond and inflation linked bond yields at the various maturity points.
| ||Maturity |
|Benchmark Commonwealth Government Interest Rate Bonds ||5 years ||10 years ||20 years |
| 2020 ||2025 ||2035 |
|Nominal yield (1) ||2.18% ||2.84% ||3.41% |
|Inflation linked yield (2) ||0.28% ||0.61% ||1.05% |
|Market inflation expectation = (1) - (2) ||1.90% ||2.23% ||2.36% |
On the surface, the implications for portfolios invested in inflation linked bonds (ILBs), be they capital indexed bonds or indexed annuity bonds, are lower accretion rates and therefore lower returns. Simplistically, total returns in the ILB sector could be expected to be lower, given actual inflation is likely to fall. The strategy for the Inflation Linked Income Investment Program, taking account the backdrop of low short to medium term inflation, looks for economic advantage that can be extracted from two sources:
- Investing in ILB’s that offer compelling relative value. By example, Sydney Airport 2020 CIB at a real yield of 3.00% plus an inflation figure of 1.90% can be expected to return 4.90% nominal equivalent. By comparison, the Perth Airport 2021 fixed nominal bond yields only 4.22% making the Sydney Airport bond an attractive investment offering an additional 0.70% of yield, given they are rated the same by credit rating agency, Standard and Poor’s. This could be also viewed in terms of a breakeven on inflation, actual inflation would need to drop below 1.20% for the whole 5 years in order for an investor to prefer the Perth Airport bond on a yield basis.
- Investing in higher yielding medium tenor floating rate notes (FRN’s) as a substitute for ILB’s. The benchmark for FRN rate sets is bank bills which are correlated to inflation as the RBA’s interest rate policy is based on inflation targets. The risk associated with this strategy is a rally in real ILB yields delivering a total performance higher than for the FRN’s care of capital gains generated by the duration exposure of the ILBs. The accrual advantage of high yielding FRNs over bank bill rate sets, compensates for this risk.
At this point in time, we favour investments in FRN’s where compelling relative value in ILBs is not available. The current portfolio mix is 80% ILBs and 20% FRNs.
For more information, please call your local dealer.