Finding a middle ground in fixed income
These are uncertain times for investors and economies. But with uncertainty, comes opportunity.
When was the last time you reviewed the percentage allocation to each major asset class in your portfolio? Is your investment profile commensurate with your age? Is your portfolio in line with what professional fund managers recommend and implement?
If you have not reviewed your portfolio for a while, now is an opportune time to reassess your asset allocation. A balanced and diversified portfolio is the best form of protection during unprecedented times.
Below is AustralianSuper’s ‘Conservative Balanced’ portfolio, suitable for someone 60+. How does your SMSF compare?
Typically what we find is that the average SMSF is over-allocated to equities, over-allocated to property, and over-allocated to cash, whilst being under-allocated to fixed income.
Australia’s wealth has primarily been built on property, and the ease of access to a resilient equity market means these asset classes will always be the cornerstones of the Australian investment landscape. But why does the fixed income market lag so far behind? One may assume it is due to lack of knowledge about the asset class, and/or difficulty in accessing the fixed income (bond) market.
A major reason for this is that a bulk of the world’s bonds trade in an ‘over-the-counter’ market, as opposed to being listed on an exchange. So you need a broker, with access via the Bloomberg trading system, to accurately price and trade these products.
In addition, traditionally it has been available to wholesale/sophisticated investors only, which means one requires net assets of $2.5M to participate. This includes all assets you own, inside or outside of your super, including your main residence. Nonetheless, it seems ridiculous that retail investors can throw their life savings into whatever ‘penny stock’ they like on the ASX, but cant buy investment-grade bonds? This is something that is unique to Australia and is the result of an antiquated Corporations Act.
These barriers to entry are slowly being removed, and whilst in the wholesale market, we’re trading with $50,000 minimums, we’re seeing an increasing number of ‘retail offers’ being listed in smaller denominations on the ASX. This increased exposure and ease of access is a positive step that will help broaden the market in Australia.
Too much cash?
A potentially easy way to boost your portfolio returns is to first of all see if you are holding too much cash. Of course, nothing can match the liquidity that cash offers, but right now having too much cash is inefficient . The banks have access to so much cheap money that they do not even want your cash. Hence, they are not going to offer anything more than the bare minimum return.
An investor must at least look to earn a a return higher than CPI. Otherwise, in real terms, you are going backwards. Investing in fixed income can help you create a defensive portfolio of high- quality investment-grade bonds, and still generate a return greater than CPI.
Of course, compared to cash there is some exposure to corporate credit, but senior bonds, in household names, offer excellent liquidity, and in comparison to equities, there is only a negligible increase in risk.
For example, below are recent new issues:
- Transurban @ 3.25%pa
- Lend Lease @ 3.70%pa
- Aurizon @ 3%pa
- WestConnex @ 3.15%pa
- Ampol @ BBSW+3.60%pa
There has been unprecedented demand for these issues from the institutional market, with over-subscription of 3-5 times the issue size. For example, the Lend Lease deal was for $300m, and they received $1.2bn in bids.
Professional investors see value in investing in quality corporate names, that could help generate returns better than the CPI. The recent quarterly inflation numbers were surprisingly low, denting any hopes of significant growth. What is quite scary is that we’ve had substantial stimulus pumped into the economy, and still can’t get to the bottom end of the RBA’s targeted range of 2-3% inflation.
Such has been the demand in these large high-quality issues, that, in addition to the usual ‘new issue premium’, we’re seeing bonds rally in price as soon as they hit the secondary market. This presents an opportunity for further gains for investors – ie, buying in the primary market at the ‘par’ price of 100 and selling at prices in the range of 102 – 104. Bond are issued with some regularity, allowing investors to recycle capital 2-3 times a year, often resulting in double digit returns from investment-grade bonds.
Too many equities?
The fixed income market is huge – over five times the size of the global equity market. This means it’s broad in terms of the quality, and currencies on offer.
Earlier in the article, I highlighted the defensive nature of fixed income, as a cash alternative. Now I’ll turn to the high-yield side of things – generating equity-like returns, without being in equities.
If you’ve had a stellar run on the ASX, and are thinking that it might be time to take some profits off the table, high-yield bonds can provide a decent return, with regular income payments, over a set period of time.
Some recent examples include:
- MoneyMe @ 8.25%pa
- Bennelong Finance @ 10%pa
- Pallas Capital @ 7.5%pa
- Aus Pacific Mortgage Fund @ 7%pa
Finding middle ground
The Australian SMSF investment mix is, as a general rule, over-exposed to equities, property, and cash, and under-exposed to fixed income. Industry and retail funds include anywhere between 15% and 50% in fixed Income, depending upon whether it is an aggressive or conservative mandate.
When was the last time you did a complete review of your asset allocation? Are you treating your SMSF as a professionally managed fund? Is your investment profile out of alignment with your age?
Fixed income really is the ‘middle ground’ between cash and equities, in terms of risk and reward. Whether you have surplus cash and want a high-quality, liquid portfolio designed to beat CPI, or if you’re coming from equities and want to play in the high-yield market, there is a diverse range of fixed income products available that may add value to your investment portfolio.
*Cameron Window, Executive Director - Fixed Income, Bond Income