The hit taken by share markets over the past three weeks following the Chinese market meltdown has underscored the enduring importance of a significant chunk of fixed interest in any portfolio. But, if interest rates are likely to head north again soon, what sort of fixed interest investments are best? The answer, for many investors, is: an unconstrained basket targeting absolute returns.
Daniel Sheard, an investment director responsible for the absolute return bond family at the big global fund manager GAM, says that “simple arithmetic” tells you that the relatively benign conditions which occurred for much of the past three decades will not return any time soon.
“If you look at the history, there’s been a long secular bull market in bonds as interest rates have declined from the mid-teens in the 1980s. When I started work at ANZ Bank in London [1986-1989] rates were around 15 per cent in the Australian-dollar denominated Eurobond market, which was probably the highest they got to,” he says.
Bonds, in fact, enjoyed a “miracle combination” over much of that time period through rising capital values, high current income and delivering on a negative correlation with equities in times of crisis. But those days are over.
Sheard and his GAM colleagues in London are scheduled to present in early September to a group of Australian dealer group researchers and investment professionals at the next Rainmaker group “Best of Breed” tour. The firm will also be hosting a luncheon discussion on asset allocation in today’s market conditions. Clearly, GAM likes bonds, but right now the firm’s arguments are more compelling than ever.
Asset classes are related. For individual investors, for instance, as bond yields fall, people are prepared to accept lower yields in property as prices have rise. Sheard cites Germany from about 1990 to 2009 when house prices fell by 10 per cent over the period – something which might cause riots in Australia. “Germany doesn’t have a strong culture of home ownership,” Sheard says. “But since 2009 apartment prices there have gone up about 30 per cent. So, even the Germans have discovered real estate for the private investor. Low interest rates have this incredible power to distort people’s behaviour.”
The GAM Absolute Return Bond Fund, which has a long history and attracted funds flow from both institutional and advised individual Australian investors in recent years, dates back to 1983 in the UK, when the precursor to GAM was founded. GAM acquired the firm of Augustus, a specialist quality fixed interest shop, which itself had spun out of the old Julius Baer Investments, in 2009. Sheard is a former CIO of Augustus.
He says that the absolute returns global bond strategy, which underpins the Australian-domiciled fund, has delivered an average of 100bps of alpha per year for just over 30 years. The fund not only rode the bull market, it added to the returns through skill. The fund is rated by both Lonsec and Zenith in Australia and appears on one of the Lonsec model portfolios.
GAM’s absolute returns team aims to provide “a diversification of active ideas”, as Sheard puts it. He is aware of “spurious diversification” which won’t necessarily deliver the protection that an investor is looking for. For instance, if an investor buys 4,000-5,000 of the universe of about 12,000 securities, he or she will get only the market return. Such an investor would be better off buying a cheap index fund.
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