3 pockets of opportunity in fixed income

Glenn Freeman  |  07/06/2017Text size  Decrease  Increase  |  

Glenn Freeman: I'm Glenn Freeman for Morningstar Australia. I'm joined today by Robert Mead, managing director and head of portfolio management with PIMCO Australia.

Robert, thanks for joining us today.

Robert Mead: My pleasure.

Freeman: Now, what's your view on the role of fixed income within retail investment portfolios? Has this changed in recent times?

Mead: I think it's a really good question and the way I sort of think about it is, Australian investors are thinking about three really important issues when they build their portfolios.

The first one is, 'do I have too much exposure to equities or Australian residential property?'.

Second one is, how am I going to generate income in retirement.

And the third one is, there's general fear about interest rates going up even though so far, they have been very steady and actually in more recent times going back down.

So, when you think about the role of bonds or fixed income more broadly in that context to address those three issues, I would say an actively-managed bond portfolio and having that as a part of the mix ticks all three boxes.

So, it's negatively correlated or at least lowly correlated versus other risky assets like property equities.

Bonds generate a stable income stream. And also, if you actively manage bonds, then if there is the fear or there's the likelihood of interest rates going up, the manager can then take preemptive action and start to de-emphasise interest rate risk as a part of that portfolio.

Freeman: Now, Robert, in the current market, do you see any particular pockets of value for retail fixed income investors?

Mead: The high-quality credit part of the marketplace, we think, is still attractive whether that be at the senior level or even further into the subordinated sectors.

In terms of the overall portfolio, I think it's still important to ensure that there is diversification. So, while there is nothing wrong with, say, an Australian bank hybrid, they are fine investments to have as a part of the portfolio mix, they are correlated with other things that we know are in portfolios.

So, again, we always keep stressing that as long as there's diversification in the overall portfolio, that's the most important element.

The other thing we like are things like securities that are backed by US housing, which is much more robust in terms of its price outlook than the very expensive Australian housing market.

We also like looking at the global banking sector, some of that in the subordinated sense, really given the fact that some of the European, Swiss banks, other jurisdictions were really penalised post-crisis and they have had to recapitalise very aggressively since. So, that would stand out as another one of the parts of the credit spectrum.

Finally, we still like Australian high-quality, even Commonwealth government bonds in the three to five-year sector. The RBA is not going anywhere.

We think 1.5 per cent will remain the cash rate and the policy rate for the balance of 2017. And there's enough noise out there to suggest that some really high-quality duration in a portfolio sense makes perfect sense in the mix.

Freeman: What are your thoughts on the quality of Australian credit issuers? Are the prices accurately reflecting the risk?

Mead: I think so. So, if you split the market into industrials and financials, the industrials, many of which they issue in Australian dollars, look like at least fair value, if not marginally cheap versus their global peers.

But when you look at the Australian banks, especially at the senior level, spreads are getting quite tight. So, I would be sort of thinking about the market more bifurcated from industrials to financials, with a preference in Australian dollars more into the industrial space at the moment.

Freeman: What's your view on the active versus passive management debate? How is that reflected within the fixed income environment?

Mead: Yeah, it's a great question. It's obviously a hot topic and there's lots of different views out there. So, I'd make a couple of comments.

First thing is that based on all of our independent data analysis, there's a compelling view based on the data that the fixed income universe of managers has done a lot better job in terms of outperforming their designated benchmarks than in the equity universe. So, then you ask yourself, why. We do think there are some inherent reasons why.

So, first of all, central banks own a large share of various bond markets around the world. They are less focused on outperforming any benchmark. They are really focused on just absorbing some of the bond supply in a quantitative easing scene. So, there are some noneconomic players that are participating in bond markets, much less so in equity markets.

And also, bond markets, bond portfolios, bond indices change quite dramatically. So, every time a new issuer comes to market with a new bond, or a bond matures, the universe changes. So, it's constantly changing, which provides opportunity.

The final thing I would say is, active management is still not easy. So, finding managers that can consistently outperform, I think the role of those managers in portfolios is going to become even more important as some of the other components of an asset allocation move towards passive.

Freeman: Thanks for your time today, Robert.

Mead: It's a pleasure. Thank you.

Freeman: I'm Glenn Freeman for Morningstar. Thanks for watching.

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