The universe of fixed income funds now provides more opportunities for convenient access, portfolio diversification, and more precise execution, although there are also reasons for caution, writes Kathryn Young.
More than 30 fixed income managed funds and exchange-traded funds have been launched in Australia in recent years. A few key themes stand out. We’re typically wary of such clusters, because they often represent the latest fad which has performed well over a short period. In this case, however, many of these are positive potential additions to investors’ and advisers’ opportunity sets, because they signal the entrance of some world-class fixed income fund managers to this market, and potentially offer more flexible ways to achieve investor objectives.
Unconstrained is the new black
More than half the new unlisted funds are in our Multi-Strategy Income and Diversified Credit categories, and include funds such as Goldman Sachs Global Strategic Bond, Kapstream Absolute Return, Macquarie Income Opportunities, and PIMCO EQT Unconstrained Bond. These are designed for investors who want more income than most traditional fixed interest offers at the moment and to cater for those concerned about future interest rate increases eating into that slim margin of income. They do not use a benchmark to guide their investment universe, instead selecting flexibly from a variety of sectors.
Multi-Strategy Income funds are typically more global and have greater exposure to sectors such as high-yield credit and emerging market debt. Diversified Credit funds typically focus more on investment-grade corporate bonds and notes, many having almost no interest rate exposure. Most Multi-Strategy Income funds will have some duration, though it will generally be limited and fluctuate on the basis of the fund manager’s view.
We believe these approaches have merit, but there are reasons for caution. Most have relatively short track records, take on meaningful credit risk, and can be fairly tactical. It will be important to monitor how these funds manage through rising interest rate and difficult credit environments.
Going global
Another striking trend has been a wave of global bond options, including Fidelity Global Strategic Bond, Franklin Templeton Global Aggregate Bond, and T. Rowe Price Dynamic Global Bond. The Fidelity and Franklin Templeton strategies are benchmarked against the Barclays Global Aggregate Index ($A hedged), which indicates that they will invest in a mix of government bonds, investment-grade corporate issues, and asset-backed securities, maintaining duration in broadly the four to seven year range. In keeping with the new style, however, they will be quite flexible around the benchmark. The T. Rowe Price offering also possesses this kind of flexibility – it uses a cash benchmark – but is designed to have enough duration to be a portfolio anchor. It invests substantially more in Australian bonds than the Fidelity and Franklin Templeton options.
Also new to Australia are three emerging market debt funds – Goldman Sachs Growth & Emerging Markets Debt, Lazard Emerging Markets Total Return, and Mercer Emerging Markets Debt – which offer yet another way to diversify by investing in local and hard currency emerging market issues. Most leave that currency exposure unhedged. We’re fans of diversification, and think there are some skilled fund managers operating in this area. However, we question whether most investors need a dedicated emerging market debt allocation, given that a number of the global strategies incorporate it when the managers believe the prospects are attractive.
ETF proliferation
The number of new fixed income ETFs launched in the past few years represents more of an increase in the depth of the landscape than the breadth, because for the most part they offer new ways to get access to traditional areas of the market. Some, including iShares UBS Composite Bond IAF offer broad exposure to the local market, including government and corporate issues, through a listed vehicle. Others provide access to specific market segments in a fairly liquid and passive way. Russell launched three vehicles focused separately on Commonwealth, semi-government, and corporate bonds. iShares UBS Government Inflation ILB, which invests only in Australian inflation-linked government issues, and Vanguard Australian Government Bond (AU) VGB are similar offerings.
Such targeted exposure is probably unnecessary for most investors. Some sectors of the local bond market remain shallow in terms of issuance, which concentrates the ETF portfolios. For example, Russell Australian Select Corporate Bond RCB had only five holdings at 30 April 2014, all of which were issued by just two of the major banks. Still, these vehicles may prove useful for quick and targeted portfolio implementation.