Chasing income in a low return world

Glenn Freeman  |  10/08/2016Text size  Decrease  Increase  |  

Glenn Freeman: Do you believe the risk profile of bond portfolios has changed in recent times, and if so, is this a fundamental shift?

Paul Reisz: Really, it's not so much that the risks of bond portfolios have changed. The key objective is the same that bond portfolios are an anchor in any asset allocation, they can be a core part of any portfolio and they should help to stabilise the portfolio when you have more volatility, let's say, in risk assets like real estate or equities.

What has changed though are the markets. Yields are low and there has been a lot of volatility and there have been a number of events that have cropped up that have led to uncertainty.

And so, really having a core allocation to bonds, having an anchor in the portfolio has helped to stabilise portfolios for investors.

Freeman: In Australia, 10-year bond yields are at historic lows. Does this represent an opportunity for individual investors? Does this align with the global situation?

Reisz: They actually do. Yields are low around the world and if you look at Japan or in Europe, yields are negative.

So, in Australia yields are low but yields are still relatively high compared to other regions of the world.

The opportunities though that are created are really coming from just a number of different sectors and really as long as you have flexibility in managing portfolios, as long as you can invest globally and then take risk into consideration, so think about ways to invest even in lower-yielding sectors but do those sectors provide ballast or stability in portfolios?

And that does create opportunities because in this environment you just have to be careful.

Investors tend to stretch for yields, stretch for returns. So, as long as portfolios are well-balanced then it does create opportunities that others might overlook.

Freeman: Where can risk-sensitive investors find yield in the current marketplace?

Reisz: There are really a number of sectors that we think are attractive in this environment.

If you think about the global economy, that's muddling along, but the US economy has been growing at a relatively steady pace and the real estate market in the US has been appreciating.

So, one of the sectors that we do favour, that we're constructive on ,is the residential real estate market in the US and we found some sectors of the mortgage market in the US that have relatively attractive yields above even the cash yields in Australia as an example and we're able to buy these bonds at relatively attractive discount and our expectation is that as the real estate market continues to appreciate, these are bonds that yield in the mid-single-digits, so they're relatively attractive.

But we always balance our portfolios and we think about ways to keep the portfolios stable. So, there are some sectors that may have high yields but their prices may bounce around.

And when that's the case, what we'll do is we'll balance our portfolios with higher-quality securities.

As an example, we've been buying Australian government bonds which in the overall scheme of things actually compared to negative yields in Europe and in Japan are relatively attractive securities to buy and they are fairly stable.

So that's the way we think about it is that there are some sectors that provide attractive yields. We just want to balance our exposure to those sectors with high-quality liquid securities as well.

Freeman: Can you explain the distinction between constrained and unconstrained bond funds - what are the pros and cons of each?

Reisz: So, most portfolios have some kind of constraint and really it's the key objective in any portfolio.

The difference is how much flexibility a portfolio manager may have in managing the portfolio.

So, how closely would a portfolio manage a fixed income portfolio versus a benchmark versus, let's say, managing a portfolio just versus a cash rate and trying to beat that cash rate.

And so, the benefits of a constrained portfolio would be that an investor would know more or less what they are investing in, they know what that benchmark represents and they know that it's fairly reflective of the style of the portfolio and what they are investing in.

With an unconstrained portfolio the benefit is that you are not tethered or tied it to any specific benchmark.

You can invest in any sector globally. But I guess the disadvantage generally is that an investor may not know exactly what they are investing in.

So, even there if you bring that back to an asset allocation, it makes sense to have a core holding, let's say, a strategy that really is just a traditional core global strategy and then supplement that with an unconstrained strategy that might provide benefits in different economic environments.

Freeman: What's the next frontier for the fixed income sector?

Reisz: In the fixed income sector there are a number of sectors, a number of instruments that have been created that we find to be interesting.

But we always look at risk-adjusted returns and we just want to make sure that we understand those securities, understand the sectors and understand the potential downside associated with them.

So, what I would say is even as those new securities are being created, fixed income really should be, what I would say, is a stabilizer or an anchor in any portfolio.

So, even if we do see new sectors that are interesting, those will start to evolve over time. But for investors when they think about an overall asset allocation, just investing in fixed income should provide stability, should provide an anchor, as I said, as compared to equity strategies or real estate strategies.

And then those core fixed income strategies should and can be supplemented with new sectors, new areas of the market that may become fairly interesting and they pop up all the time.

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