Managed fund researcher Zenith Investment Partners has given its highest rating to four funds in its latest review of the Australian fixed income sector. It also found that the “critical success factors for outperformance” in the sector are changing.
The four ‘highly recommended’ funds are Legg Mason Western Asset Australian Bond Trust, Pimco Australian Bond Fund, Pimco Australian Short Term Bond Fund and UBS Cash-plus Fud.
Three funds were upgraded: Perpetual Wholesale Dynamic Fixed Income Fund to ‘recommended’; Yarra Enhanced Income Fund to ‘recommended’; and Realm High Income Fund to ‘recommended’.
The Schroder Fixed Income Fund was downgraded to ‘approved’.
From a universe of 97 Australian fixed interest funds, Zenith rates four ‘highly recommended’, 28 ‘recommended’, 14 ‘approved’ and 51 ‘not rated’
For the 12 months to the end of April, the median bond fund return was 2.09 per cent, compared with a return of 2.16 per cent for Bloomberg AusBond Composite Index.
Dispersion of returns, the performance spread between the upper and lower quartiles, was the lowest in over a decade.
Zenith says the Australian fixed income has developed greater “co-dependency” with offshore bond markets. The presence of a large proportion of non-resident corporate debt issuers means that fund managers have to address questions such as whether to place greater emphasis on global economic factors in their strategies, and whether they should have portfolio managers posted overseas.
“Over the last decade, the Australian fixed income sector has changed from a domestically biased market to a more diversified market with an increase in global issuers,” the review says.
“There is a greater two-way flow of capital, with more non-resident issuers in the local market and more domestic issuers diversifying their funding sources offshore.”
This increased level of two-way capital flow is representative of a global market, where risk is priced in a global framework. For example, spreads on bonds issued by Australian banks in the Australian market have a strong relationship with spreads on bonds issued by US or European banks in global markets.
Further evidence of the two-way capital flow is that 50 per cent of Australian commonwealth government bonds are held by foreign investors – up from around 10 per cent a decade ago.
“The critical success factors for generating outperformance are evolving in response to these trends,” Zenith says.
“The opportunity to generate excess returns from active interest rate and yield curve management has increased. To achieve this, managers will need to demonstrate proficiency in understanding global monetary themes and synthesising these into a local bond market context.”
Access to research produced by offshore credit teams is a “competitive advantage”, as is greater mandate flexibility.
Size is another advantage because it brings opportunities such as offers to be a cornerstone investor, which may offer pricing advantages.
Zenith says that since the early 2000s, the influence of US Treasuries on Australian government bond returns has increased, explaining 60 to 70 per cent of return volatility.
Another development is the increasing complexity of the fixed income market, with a substantial increase in the number of corporate issues, from around 350 in 2009 to more than 600 last year. Over the same period corporates have tended to extend their debt maturities through the issue of longer-dated bonds.