Opportunities in fixed income

Nicholas Grove | 28/10/2014

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Nicholas Grove: I'm Nick Grove for Morningstar.com.au, and today I'm joined by Bentham Asset Management's Richard Quin, who is here to discuss short duration credit.

Richard thanks for your time today.

Richard Quin: Thanks, Nick. It's a pleasure to be here.

Grove: First of all, Richard, for the uninitiated, can you just give us a brief explanation of what is meant by short duration credit?

Quin: Short duration credit is basically something that gives you a margin over a bank bill or cash rate. Now that cash rate or bank bill rate may go up and down, and that's why we sort of call them floating-rate notes because they float over that cash or bank bill rate.

Now, the key thing about short duration credit is it doesn't have that much interest-rate sensitivity. So if interest rates go up, it doesn't lose value. It actually increases its yield. So it's really good in a rising interest-rate environment.

Grove: Richard, what are the main benefits of this asset class, particularly for retail investors, and what advantages does it have over other asset classes such as long bonds or equities?

Quin: It's a very different asset class. It sits in the middle of the risk (curve) for different asset classes. Like long bonds and cash are seen as being lower-risk instruments and then equities are seen as being higher-risk instruments. Now, credit sort of fits in the middle between those two and it has a number of sort of benefits. It tends to generate a higher income than cash and bonds, and that's because you're taking on margin risk or credit risk.

And it also can be quite resilient because of its seniority in the capital structure -- it has security and it's seniority in the capital structure means it's more resilient should you see a downdraft in markets. It may fall in value a bit, but it tends to recover, and that's an important thing with the different assets.

And lastly, it just has that income-producing nature to it.

Grove: What is the current relative value of global credit compared to other sectors?

Quin: This is an interesting one. I think a lot of people look at credit right now and say it's a very expensive asset class. I think when they say that they're actually looking at long-term bond rates because interest rates are very low right now and we'd expect interest rates to rise, and so relative to say fixed-rate bonds, we think credit actually provides a pretty good margin or yield.

Likewise, it's not as reliant on growth, as say equities. And one of the things we find ourselves now in is in environment that has slightly lower growth globally, and that's a key component to sort of generating returns for equities. So, you don't need that in credit.

Grove: Richard, financials dominate the credit sector in Australia. So how effectively can short duration credit diversify portfolios, especially given the prevalence of the bank equities in many individuals' portfolios?

Quin: Listen I think this is probably the most important thing for investors right now, especially self-managed super investors, and they've a very correlated portfolio with bank stocks, property and maybe hybrid bank securities.

I think, the thing with a global credit portfolio, you can actually diversify away from Australia and pick up a good yield and be in markets that have liquidity and an ability to invest more broadly. You can invest in industries that just don't issue debt in Australia and are very diversified relative to say the Australian investment environment, which is predominantly banks and miners.

Grove: Finally, Richard, why would investors access global credit in a managed fund format?

Quin: It's hard to do. To be honest, if you want to hedge global securities back into Aussie dollars, your normal small investor can't do that, and even a lot of large investors find it difficult to do. That's one thing. It's hard to hedge it back into Australian dollars, but also it's hard to get enough people to do the research. You need a lot of diversity, you need three to four times the diversity you have in, say, an equities portfolio and because of that you need someone who specializes in it and has the research capabilities to cover and do the in-depth research per issuer. And that's why a lot of large superannuation funds use us.

Grove: Richard thanks very much for your time today.

Quin: Great. Thank you.

This report appeared on www.morningstar.com.au 2017 Morningstar Australasia Pty Limited

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