Tuesday 24 October 2017 by Kieran Quaine Trade opportunities

MIPS quarterly report – ongoing impressive returns in a low rate environment

MIPS three investment mandates - Conservative Income, Core Income and Income Plus, as well as the customised portfolios continue to perform. This note summarises the portfolio management team’s views on the market and how they are adjusting portfolios to reflect their expectations  


The MIPS programs performed strongly during the quarter – a period that encompassed a weak interest rate curve and stable investment grade credit margins and slightly weaker non investment grade and unrated credit margins. 

Key themes:

  • US and Europe exhibit further evidence of improved economic growth
  • Australian labor force growth improvement is significant
  • US Federal Reserve:
  • Monetary policy path is ‘tighter’
  • Balance sheet support of marketable securities to be withdrawn
  • Portfolio Management Team retains short duration

The MIPS investment returns net of fees, are contained in Table 1 below. These returns are the averages across all individually managed accounts on an actual basis.

MIPS investment returns

Source: FIIG Securities
Table 1

Benchmark performance

Evaluation of the investment program returns is assisted by comparing to benchmark indices. The following indices delivered the following 3, 6 and 12 month returns, noting those indices are GROSS returns, respectively:

  • The S&P/ASX Australian Fixed Interest 1 to 5 year maturity index delivered 0.24%, 0.88% and 1.11%
  • The S&P/ASX Corporate Bond BBB Rating Band index delivered 0.84%, 2.12% and 3.62%

The low absolute benchmark performance is a function of the weak yield curve as shown in Figure 1. 

Key contributors to September returns

The interest rate curve weakened marginally during the quarter. See Figure 1 below. That interest rate directional weakness contributed negatively to performance in the order of 0.20% across all programs given average duration exposure within each of approximately two years.

Duration exposure continued to be shortened for the Core and Conservative programs but maintained for Income Plus, which is already very short, consistent with the team’s interest rate view. 

Investment grade credit exposure performed well, with credit margins rallying (contracting) slightly. Subsequently the Core and Conservative Income Investment Programs outperformed the Income Plus Investment program.

Non investment grade and unrated credit margins weakened during the quarter. That weakness contributed in the order of negative 0.30% for Income Plus that has near 67% exposure to that sector. However the return of 0.69% net of fees despite interest rate and credit weakness is testimony to the advantage of high accrual yield in this environment.

Interest rate outlook – unchanged

The team determined that the RBA will be reluctant to tighten too early for fear of damaging frail consumer confidence, and will be quite comfortable with a fall in the $A that will likely result. But the reasons for future monetary policy tightening are mounting so the yield curve will likely steepen further with minimal opportunity for capital gains in longer dated bonds.

Subsequently the team has set all portfolio exposure at short duration, not seeing value investing longer across the yield curve, given the US Federal Reserve and potentially the UK are raising rates off all time lows.

Australian fixed interest rate swap curve changes

Source: FIIG Securities
Figure 1

Inflation outlook – inflation remains low

Inflation expectations in Australia are unchanged this quarter and remain below the lower bound of the RBA’s 2-3% target band, see Figure 2. We expect inflation will remain at the lower end of the RBA band at near 2%, with a gradual pick up as the economy strengthens and employment growth of recent note is solidified.

We believe there will be a lower impact upon inflation, than in prior periods, as a function of a currency devaluation. Significant competitive forces in product distribution are continually pushing costs down and consumers will likely benefit.

Year ended percentage change in inflation

Source: FIIG Securities 
Figure 2

Credit outlook

The most significant change during the quarter was the increased allocation, within Income Plus, to investment grade subordinate and non investment grade and unrated credit out of investment grade credit. That exposure change was a function of opportunity to diversify further, as well as slightly weaker credit margin differentials.

Diversity of portfolios continues to drive asset allocation particularly in the high yield sector.

Credit, as measured by the iTraxx, has continued the downward trend exhibited over the last quarter and reached the lowest it has been in the last decade.

The full report will be available on the FIIG website later this week. For more information please call 1800 01 01 81 or speak to your local dealer.