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ActiveX Ardea Real Outcome
Bond Fund (Managed Fund) (ASX:XARO)
ARSN 629 403 925
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Fund Facts – 31 May 2020
Fund Overview
The ActiveX Ardea Real Outcome Bond Fund (Managed Fund) is a defensive fixed income solution that targets stable returns exceeding cash deposit rates and inflation, with a quarterly income distribution and daily liquidity.
The Fund does this by employing Ardea’s ‘relative value’ investment approach, which combines the safety of high quality government bonds with proven risk management strategies to deliver low volatility returns, while protecting capital from interest rate fluctuations and general market volatility. (Note: neither the Fund nor the Underlying Fund are guaranteed).
Suits Investors Seeking
• a higher expected return than bank deposits1
• an alternative source of income, with low volatility
• a defensive fixed income anchor to diversify portfolio risk away from equities, property and credit investments
• investors who accept some risk and that their investment will include exposure to derivative strategies
1 Neither fund performance nor capital is guaranteed.
Monthly Performance Report – 31 May 2020
Fund Performance2, 3
1 month 3 months FYTD 1 year 3 years 5 years Since
inception4
Fund 0.38% 0.17% 4.80% 5.89% - - 7.35%
Australian Consumer Price Index
-0.37% -0.25% 1.20% 1.40% - - 1.31%
Excess Return 0.75% 0.42% 3.61% 4.49% - - 6.04%
2 Performance figures are based on the Fund’s net asset value, are calculated after fees have been deducted and assume distributions have been
reinvested. No allowance is made for tax when calculating these figures. Past performance figures that are less than 12 months are for informational
purposes only and are not to be relied upon when considering the likely future performance of the fund.
3 The performance of the Fund will not exactly replicate that of the Underlying Fund, for example, where cash is held by the Fund
4 The Fund’s inception date is 10 December 2018.
Source: Fidante Partners Limited, 31 May 2020.
Underlying Fund
The Fund invests in Ardea Real Outcome Fund (Underlying Fund). In this report, where we refer to the Fund’s investments we generally do so on a ‘look-through’ basis; that is, we are referring to the underlying assets that the Fund is exposed to through its investment in the Underlying Fund.
Underlying Fund Performance5
1 month 3 months FYTD 1 year 3 years 5 years Since
inception6
Underlying Fund 0.39% 0.21% 4.83% 5.94% 5.13% 4.24% 4.23%
Australian Consumer Price Index
-0.37% -0.25% 1.20% 1.40% 1.64% 1.61% 1.83%
Excess Return 0.75% 0.47% 3.63% 4.54% 3.49% 2.63% 2.40%
5 Performance figures are calculated after fees have been deducted and assume distributions have been reinvested. No allowance is made for tax
when calculating these figures. Past performance is not a reliable indicator of likely future performance.
6 The Underlying Fund’s inception date is 20 July 2012.
Source: Fidante Partners Limited, 31 May 2020.
ASX Ticker XARO
Fund Inception Date 10 December 2018 Fund Size $178.0 million
Underlying Fund Inception Date 20 July 2012 Underlying Fund Size $3.9 billion
Distribution Frequency Quarterly Unit Registry Link Market Services
Management Fee 0.50% p.a. Fund Issuer Fidante Partners Limited
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Underlying Fund Exposure
Sector Exposure
Government – National 38%
Government - State 62%
Total 100%
Interest Rate Duration (years)
12-month average 0.2
Since inception average 0.1
Rating Exposure
AAA 76%
AA 24%
Total 100%
Region Exposure*
Australasia 65%
Europe 23%
North America 12%
Total 100%
* Australasia = Australia, New Zealand, Japan; Europe = France, Germany, UK; N. America = USA, Canada
Sources: Ardea Investment Management, S&P Ratings. Noting investors accept some risk and that their investment will include exposure to derivative
strategies.
1 Neither fund performance nor capital is guaranteed.
2 Inception date is July 2012. Past performance is not an indicator of future performance.
3 Refers to the Fund’s historical track record since inception
Monthly Commentary
Notable events for the month are summarised below and more detailed discussions of topical market themes are available here - Ardea's market insights.
A summary of Ardea’s ‘relative value’ investment approach and portfolio construction process is provided at the end.
What happened?
Growing momentum toward re-opening economies and the ongoing deluge of fiscal + monetary stimulus were the
Fund Benefits
Higher expected returns than cash and term deposits1
The Fund has a track record of delivering returns exceeding cash, term deposits and inflation since inception2. As
these returns are independent of market direction, Ardea expects to maintain a level of outperformance in rising
and falling markets irrespective of the level of cash or deposit rates.
An easier way to access your investment
The Fund offers daily trading on the ASX, without break costs that can apply to term deposits.
Lower risk than many common investment income sources
The Fund invests in high-quality government bonds and cash securities, which have lower credit risk, unlike bank
hybrids and corporate bonds, while also using sophisticated risk management strategies to minimise volatility
compared to dividend paying stocks.
Defensive fixed income anchor that helps diversify investment portfolio risk
The Fund targets positive returns that are independent of interest rate fluctuations and general market volatility.
Combining this with proven risk management strategies allows the Fund to help diversify your portfolio risk away
from equities, property and credit investments.
Protect the purchasing power of your cash
In addition to outperforming3 bank deposits, the Fund targets returns exceeding inflation, which helps protect the
long term purchasing power of your cash.
Experienced and stable investment team: Ardea’s investment team has decades of experience across global
fixed income markets. Majority employee ownership of the Ardea business fosters team stability.
Fund Risks
The Fund is exposed to a number of risks including interest rate risk, market risk, and collateral risk. Please refer
to the Product Disclosure Statement for more information.
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dominant themes in May. In response to this, risk asset prices have rebounded aggressively from the March lows. Looking at risk asset prices alone would suggest everything is awesome, but investors were actually faced with a mélange of contradictory signals (or noise?).
We start with a few charts for context.
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The 3-way tug of war between horrible economic data, extraordinary stimulus and easing lockdowns continued through May. On the economic data front, things were generally awful everywhere.
“It took just one month for the labor market in the world’s largest economy to capsize. It will take longer for the damage to be fully realized. In the harshest downturn for American workers in history, employers cut an unprecedented 20.5 million jobs in April, tripling the unemployment rate to 14.7%, the highest since the Great Depression era of the 1930s. And it’s only set to worsen in May, as cuts spread further into white-collar work”
- Bloomberg, ‘Job Losses for 20.5 Million Americans Herald More Pain to Come’, 8th May 2020
“The euro-area economy is faring worse than hoped, facing a recession as bad as the European Central Bank’s more pessimistic forecasts. Output is set to shrink between 8% and 12%, ECB President Christine Lagarde and Vice President Luis De Guindos both said on Wednesday, calling a milder scenario out of date. The remarks highlight the severity of the repercussions for Europe after businesses were forced to close because of the coronavirus pandemic, costing hundreds of thousands of jobs and furloughing millions
more.”
- Bloomberg, ‘ECB Says Euro-Area Economy Is Headed for Worst-Case Slump’, 27th May 2020
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“Nearly half of commercial retail rents were not paid in May. Companies as big as Starbucks say the financial devastation from the shutdown has left them unable to pay their full property bills on time. Some companies warn they will not be able to pay rent for months. The problem for the broader U.S. economy is that when businesses like Ross Stores and T.J. Maxx stop paying rent, it sets off an alarming chain reaction. Landlords are now at risk of bankruptcy, too. Commercial real estate prices are falling. Jobs at property management companies and landscapers face cuts. Banks and private investors are unwilling to lend to most commercial real estate projects anymore, and cash-strapped city and local governments are realizing the property taxes they usually rely on from business properties are unlikely to be paid this
summer and fall.”
- Washington Post, ‘The Next Big Problem for the Economy’, 3rd June 2020
However, a few green shoots are emerging as lockdowns ease and economies re-open.
The latest US job market data surprised to the upside – “Today's ADP private employment change for May
came in at nearly -3mn, substantially better than consensus of -9mn. While this is just one number, it does come after last Thursday's surprising near 4mn decline in continuing weekly jobless claims. That suggests to us that economists may currently be underestimating especially jobs creation in parts of the country that have made progress in reopening.”
- Bank of America, Situation Room, 4th June 2020
Survey based leading economic indicators improved in Europe – “Across the EMU4, the services activity
PMI indicators are now higher than in March, but those for employment are lower. Our European economists note the increases are a welcome sign of activity improving over the course of May but question whether the PMIs might be overestimating the recovery on the way up as remaining social distancing restrictions will be severely affecting a relatively narrow set of industries.”
- Deutsche Bank, DB Daily, 4th June 2020
Global manufacturing PMI’s also rebounded – “The global headline manufacturing PMI rose in May, to 42.0
from 39.7 in April. Encouragingly, the new orders index –which tends to be a forward-looking indicator – rose more than headline PMI, by 5.4 points in May. We expect further improvement in June’s PMIs as that data will capture the effects of a full month from the reopening of economies. The higher-frequency indicators, such as mobility and spending data, suggest that a recovery in demand has gathered momentum in recent weeks.”
- Morgan Stanley, Global PMI Update, 2nd June 2020
Some banks are optimistic about a V-shaped economic recovery, while others remain sceptical.
“Globally, the coronavirus crisis has pushed the economy into a deep recession. We expect real GDP to contract by 3.8% this year, making 2020 weaker than the year following the Global Financial Crisis. But we believe global economic activity has now bottomed and expect a strong sequential recovery in advanced economies in 2H 2020, assuming infection rates don't reaccelerate sharply as economic activity continues to recover, prompting the reimposition of control measures.”
- Goldman Sachs, Macro at a Glance, 4th June 2020
“Citigroup said financial markets were ‘way ahead of reality’ with tougher times to come, warning corporate clients that they should raise as much money as they could before the pandemic’s true cost is factored in by investors. ‘We definitely feel that the markets are way ahead of reality. We really are telling every client to tap the market if they can because we think the pricing now couldn’t get any better,’ Manolo Falco, investment banking co-head at Citigroup, told the Financial Times. As the second quarter comes along and we start seeing the pain, and the collateral effects of that, we think this is going to be much tougher than it looks.’”
- Financial Times, ‘Citi warns markets are out of step with grim reality’, 31st May 2020
Meanwhile, the severity of economic disruptions started manifesting in rising credit default rates; something we haven’t seen in a meaningful way since the 2008 financial crisis (GFC).
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“Over the past four months, at least 104 companies that rank below investment grade have drawn down
roughly €32.2bn from their loan facilities from global banks, according to data from 9Fin, a fintech data provider that has scraped the filings of European bond issuers. The true figure is likely to be much higher, given that publicly traded companies are not required to report drawdowns immediately and privately held groups often have no obligation to announce them.
‘We’ve seen an unprecedented flight to liquidity, no one ever thought the whole market would draw their credit lines at once,’ said Steven Hunter, chief executive of 9Fin. ‘It’s not just the breadth of the drawdowns across the market, it’s the depth which is striking,’ he added
… Higher default rates have created a vicious cycle whereby banks are tightening up their credit facilities to protect against further defaults, giving risky companies few options but to draw down from their credit lines, said Ms. Sherman. This, in turn, creates more risk for banks later down the line.”
- Financial Times, Riskier European companies draw €32bn from bank credit lines’, 26th May 2020
“The U.S. leveraged loan market, which over the long-running, just-ended credit cycle managed to skirt wide-scale defaults thanks to borrower-friendly deal structures and strong corporate earnings, is proving no match for today's coronavirus environment.
There were 11 defaults from loan issuers in April, the most ever during a month, exceeding the previous record of 10 in October 2009, in the wake of the last major financial crisis, according to the S&P/LSTA Index. While perhaps not unexpected, the relative flood of defaults was dramatic. April's tally was more than during the entirety of 2020's first quarter, and with grim forward economic indicators thanks to the
COVID-19 pandemic, market sources expect more defaults ahead.”
- S&P LCD News, ‘In grim sign, US leveraged loan defaults set record in April’, 6th May 2020
On the stimulus front … unprecedented, staggering, Brobdingnagian … we’re running out of adjectives to describe how large the accumulated pile of fiscal + monetary stimulus has become.
“The European Union has stepped back from the brink. Again. Unprecedented in nature and ambitious in scope, the 2.4 trillion euros ($2.6 trillion) in total recovery spending unveiled by the EU -- anchored by 750 billion euros of joint debt issuance -- has already started to calm jittery markets and it might just restore a sense of unity to a bloc under severe strain.
… Facing its worst recession in living memory, the EU has crossed a new bridge: It will harness its collective strength to raise massive amounts of money that won’t need to be repaid by the recipient countries.”
- Bloomberg, ‘A Radical Plan, and $2.6 Trillion, Brings Europe Back From Abyss’, 27th May 2020
“Prime Minister Shinzo Abe doubled Japan’s stimulus measures as he looked to deliver on his bold promise to keep businesses and households afloat with the world’s biggest virus-response package. His cabinet approved Wednesday a 117 trillion yen ($1.1 trillion) set of measures that includes financing help for struggling companies, subsidies to help firms pay rent and several trillion yen for health care assistance and support for local economies.”
- Bloomberg, ‘Japan Doubles Down to Deliver World’s Biggest Stimulus Package’, 27th May 2020
“Lockdowns needed to contain the coronavirus have hit the economies of Europe and the US very hard. These blows have been blunted by enormous--indeed historically unprecedented--responses by fiscal and monetary policy authorities, actions that will prevent a repeat of the Great Depression.
Actions in the Euro Area through next year will boost the region's general government debt by an amount in excess of 17% of GDP, pushing it to record highs of well over 110%, with increasing risk that it exceeds 130%. Actions taken by the ECB could add a comparable magnitude of liquidity to credit markets, expanding the Central bank's balance sheet by up to a couple trillion euros, with more potentially on the way.
US policy actions are on a course to be significantly greater, with nearly 30% of GDP being added to the national debt through 2021, raising it to the neighbourhood of 110% of GDP, with risk of 120% or more. Actions by the Fed via both balance sheet expansion and off-balance sheet transactions with the backing of the Treasury will be on a comparable scale.”
- Deutsche Bank, ‘Global update: EA vs US macro policy responses to COVID-19’, 20th April 2020
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“Central-bank balance sheets are expanding to record levels amid their latest buying spree, raising questions about how big they can get and whether those assets can ever be sold back to markets.
… Central banks in Group of Seven countries purchased $1.4 trillion of financial assets in March, nearly five times as much as the previous monthly record set in April 2009, according to a Bloomberg Economics analysis.”
- Bloomberg, ‘The Fed Is Buying $41 Billion of Assets Daily and It’s Not Alone’, 21st April 2020
As economic data keeps getting worse, there is growing debate about negative interest rates and global government bond markets are pushing further into negative yield territory. We discussed the distortionary effects of negative rates here.
“The Bank of England is studying how low U.K. interest rates can be cut amid the coronavirus crisis and isn’t excluding the idea of taking borrowing costs below zero, according to Governor Andrew Bailey. … While officials have repeatedly emphasized such a move isn’t imminent, and would be tricky to implement in the U.K., they’ve also stressed nothing is off the table in their efforts to fight the impact of coronavirus. The fallout could push the economy into the deepest recession in three centuries.
- Bloomberg, ‘Bailey Says Time Is Right to Review How Low BOE Rates Can Go’, 21st May 2020
“Australia’s big four banks are in discussions with the Reserve Bank of New Zealand about getting their systems ready for the potential introduction of negative interest rates, which the Kiwi central bank said ‘will become an option’ early next year.
- AFR, ‘New Zealand readies banks for negative rate’, 13th May 2020
“Reserve Bank of Australia governor Philip Lowe says the ‘costs exceed the benefits’ of negative interest rates. Dr Lowe restated the central bank's former statement that negative interest rates are ‘extraordinarily unlikely’ and says there has been ‘no change’ to that stance.”
- AFR, ‘RBA's Lowe says 'costs exceed benefits' of negative interest rates’, 21st May 2020
“The U.S. economy faces unprecedented risks from the coronavirus if fiscal and monetary policy makers don’t rise to the challenge, Federal Reserve Chair Jerome Powell said while pushing back against the notion of deploying negative interest rates. … ‘The committee’s view on negative rates really has not changed. This is not something that we’re looking at,’ he said. ‘I know that there are fans of the policy, but for now, it’s not something that we’re considering. We think we have a good toolkit, and that’s the one we’ll be using.’ “
- Bloomberg News, ‘Powell Warns of Broad Virus Danger, Bats Down Negative Rates’, 13th May 2020
“The UK has sold bonds with a negative yield for the first time after a drop in inflation highlighted how the Bank of England may need to take further steps to revive price growth back to its 2 per cent target.
The country sold £3.8bn of three-year gilts at a yield of minus 0.003 per cent, according to the Debt Management Office. The slightly negative yield suggests investors who hold the debt to maturity will get
back less than they paid, when accounting for regular interest payments and the return of principal.”
- Financial Times, ‘UK sells negative-yielding government bonds for first time’, 20th May 2020
Why is it relevant?
Despite all the negative economic data, market pricing of risk assets is skewed toward optimism and that’s not necessarily a contradiction. There is a push / pull tension between current fundamentals, future outlooks, unprecedented stimulus and investor positioning, as nicely summed up by comments from two different parts of JP Morgan’s research team.
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From their economists:
“A 20.5 million US employment loss was not a surprise but still revealed a stunning convulsion that pushed the US unemployment rate up to 14.7%, the highest since 1940. This spike does not capture the full extent of the unemployment rise. Workers that left the workforce or were measured as employed but were not at work due to other reasons each rose by more than 6 million last month.
At the same time, our global all-industry PMI posted its largest one-month decline to an all-time low, led by a record collapse in the services sector component of the survey. Excluding an expected surge in China,
global GDP is on track to contract at an unprecedented 23% for this quarter.”
- JPM, Global Data Watch, 11th May 2020
From their investment strategists:
“We believe that a bullish environment in equities and risky markets is underpinned by six factors: liquidity injections; zero cash rates and low bond yields; the presence of an equity short base and equity underweights among investors; the defensive nature of the risky market rally so far; the relaxation of lockdowns and signs of bottoming out in economic expectations; and last but not least the rapid healing of
credit markets.”
- JPM Flows & Liquidity, 5th May 2020
Companies are fully exploiting investor optimism to raise debt funding and equity capital at a record pace. Companies desperate for cash meeting investors desperate for yield has made a perfect match … for the companies that is.
Companies are issuing new bonds at eye-wateringly low yields, despite raising record amounts of new debt in the midst of the sharpest economic downturn in modern history. And don’t forget that corporate bankruptcies are now hitting post-GFC record highs. How’s that for a confusing mix of events.
One explanation is a yield chasing frenzy that’s completely ignoring risk. Another is the (mistaken) belief that central bank backstops have eliminated all risk.
“U.S. public companies sold more than $60 billion in shares in May, the biggest monthly haul ever, as they capitalized on a stock market rally fueled by hopes that the COVID-19 pandemic is subsiding.”
- Reuters, ‘U.S. companies issue shares at fastest rate ever, selling the rally’, 2nd June 2020
“As the Federal Reserve pulls out all the stops to bolster credit markets, corporate America is gorging on debt. From Carnival Corp., Marriott International Inc. and Delta Air Lines Inc. to Gap Inc. and Avis Budget Group Inc., many of the companies hardest hit by the coronavirus outbreak have priced billions of dollars of bonds and loans in recent weeks. Never mind that profits have been wiped out, and that their business operations aren’t viable right now or likely anytime soon. As long as they’re propped up by the Fed,
investors are willing to lend.”
- Bloomberg, ‘America’s Zombie Companies Are Multiplying and Fueling New Risks’, 19th May 2020
“On Thursday, that boom reached an astonishing milestone: $1 trillion worth of investment-grade corporate debt sales had been brought to market in the first 149 days of the year. In 2019, a fairly typical year in the bond market, that figure wasn’t reached until November.
… In a dramatic sign of just how high the stakes are -- and how important it is for companies to maintain access to debt markets -- there have been more corporate bankruptcies in May than in any other month since the Great Recession. All of this new debt creates a new set of risks, though. U.S. companies were already highly levered coming into the crisis and by helping them heap more debt onto their balance sheets, the Fed runs the risk of deepening the pain if many of them fail to survive the virus. The central
bank also will also have to decide -- in coming months or, perhaps, years – when and how to remove the
support without sinking corporate borrowers into distress.”
- Bloomberg, ‘U.S. Corporate Bond Sales Smash Record, Soaring Over $1 Trillion’, 28th May 2020
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“Bond investors are so confident the Federal Reserve has their backs, that in some cases they’re willing to lend for barely anything in return.
Amazon.com Inc. set record low interest rates in its $10 billion offering Monday, with bondholders agreeing to receive a coupon of just 40 basis points [0.40%] for debt due in three years. … Sure, Amazon is in a league of its own in more ways than one, but here it’s part of a growing trend of companies taking out debt at minimal costs through the pandemic. Despite a rampant pace of issuance with investment-grade companies selling $1 trillion of bonds this year at the fastest pace ever, funding costs continue to
drop amid heavy inflows to the asset class.”
- Bloomberg, ‘It’s a Borrower’s Bond Market as Amazon Gets Record Low Rates’, 2nd June 2020
“Bond markets are starting to give the impression that twin dangers of the coronavirus and corporate defaults have passed. Investors should hesitate before buying in.
Retailers have been filing for bankruptcy and restructuring debt at a record pace, and more defaults are expected after the coronavirus pandemic froze some companies' cash flows and destroyed tens of
thousands of jobs. Now – with double-digit unemployment and severe pressure on municipal budgets – protests against police brutality are raging across the U.S. But investors seem undeterred by that news. While they withdrew a record amount of cash from corporate bond funds in March, they have sent all of it back into the market, along with an additional $50 billion, according to Bernstein strategists.
‘The buying of credit positions in the last 2 months is probably the clearest embodiment of the 'don't fight the Fed' narrative, combined with an absence of yield elsewhere, but it does jar with the observation that
probably the biggest default cycle in history is coming down the tracks towards us,’ the strategists wrote
in a June 2 note.”
- Dow Jones, ‘Amazon's Bond Sale Shows Debt Market Is Hot. Investors Should Be Cautious’, 2nd June 2020
In a warning sign of dangers to come, some of these recent new bond issues - barely a month old - are already going bad.
“Companies hard-hit by the pandemic rushed to raise debt last month, encouraged by the Federal Reserve’s intervention to support the credit market. But for some of the riskier names, those bond offerings have quickly curdled.
Since March 24, the day after the Fed announced its unprecedented stimulus programs, 23 companies have borrowed money in the public market at a rate of 9% or higher, according to data from Tom Graff, head of fixed income at Brown Advisory and from Refinitiv Eikon and MarketAxess.
Of those 23, new bonds from pharmaceutical company Mallinckrodt (MNK.N), movie theater chain AMC Entertainment (AMC.N) and billboard giant Clear Channel Outdoor (CCO.N) are trading around 80 cents on the dollar, a 20 point fall in the two months since they were issued, the data showed.
‘Even with how quickly things are changing in this economy, to have a deal go sour in just a few weeks is shocking. Sometimes the huge coupon is a siren song,’ said Graff.”
- Reuters, ‘COVID-era junk bond deals begin to go sour’, 21st May 2020
While central banks can artificially prop up prices, they can’t prevent fundamental credit deterioration leading to actual default risk. That’s the danger of chasing yield in the belief that central bank backstops have eliminated all risk.
This month, Hertz and Virgin Australia, both reminded us of the important difference between temporary credit spread volatility (like the fourth quarter 2018 sell-off) and actual default risk, which can lead to permanent loss of capital.
“Bonds backed by Hertz Global Holdings Inc.'s fleet of rental cars had the same credit rating as the U.S. government just a few weeks ago. Now the company's financial woes are stoking fears that investors are headed for a loss. The rental-car company missed debt-related payments last month and a deadline on negotiations with lenders and bondholders is set to expire Friday. The two sides are still far from a deal, people familiar with the matter said, increasing the likelihood that the company will file for bankruptcy court protection.
… If Hertz goes bankrupt, shareholders will likely be wiped out and owners of the company's corporate bonds would recover a fraction of face value, said Glenn Reynolds, global strategist for research firm
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CreditSights.”
Dow Jones, ‘Hertz Lenders Brace for Losses From Formerly Triple-A Bonds’, 21st May 2020
“S&P Global Ratings lowered the ratings on Virgin Australia to ‘D’ to reflect the moratorium on all creditor payments while the company is in voluntary administration. The airline’s administrators announced that the company will not pay its next coupon payment on its $425 million senior unsecured notes on May 15, due to a moratorium on all creditor payments. We consider the payment moratorium to represent a default under our criteria, S&P says.”
Bloomberg News, ‘Virgin Australia Lowered to D by S&P on Payment Moratorium’, 1st May 2020
Given all the contradictory signals about the future path of global economic growth, it is currently just as easy to concoct a bullish narrative as a bearish one. This means the uncertainties facing financial markets are unusually high.
Uncertainty and financial market volatility are close cousins. Market prices of options, which have the most direct exposure to financial market volatility, should reflect uncertainty about the future, at least to some extent. One way to measure the extent of uncertainty reflected in option prices is via a metric known as ‘implied volatility’, which is (loosely speaking) the expectation of future volatility implied by current option prices. When implied volatility is high, option markets are pricing in a high expectation of future volatility, which would be consistent with higher than normal levels of uncertainty about the future.
Given the current state of heightened uncertainty, it’s reasonable to expect option implied volatilities to be high. But in fact, option implied volatilities in equity and interest rate markets have already reversed much of their first quarter spike higher and are now rapidly heading back toward historically low levels. This appears inconsistent with the mélange of contradictory signals discussed in this note.
For some this is just an interesting observation but for those with the right expertise, it’s an attractive opportunity to implement volatility strategies that can perform very well in adverse market environments, such as the one experienced in the first quarter of this year. These types of strategies are an underutilised risk management tool that are useful for fixed income portfolios that prioritise defensiveness, performance volatility control and capital preservation, which is exactly why we’ve been adding to our volatility strategies lately.
How are we positioned?
The portfolio’s return for the month was positive.
Performance is driven by strategies that exploit specific ‘relative value’ (RV) mispricing between closely related fixed income securities. This is done in a way that isolates the RV mispricing from broader market movements, while
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maintaining minimal interest rate duration exposure and excluding all credit investments. Consequently, the portfolio’s performance is not driven by the macroeconomic factors or market movements that dominate conventional fixed income strategies and therefore exhibits minimal correlation to broader government bond, credit and equity markets.
The portfolio is intentionally constructed with a large number of modestly sized and diverse RV strategies that collectively contribute to overall portfolio performance. As the portfolio contains hundreds of individual positions, the commentary below focuses on a few of the more noteworthy RV themes that contributed to performance over the period. (Further detail on the Fund’s pure ‘relative value’ investment approach is available here.)
Noteworthy positive performance for the month came from the following strategy groups:
- RV Micro Curve
These RV strategies exploit pricing inconsistencies between different points on interest rate curves by taking a ‘long’ position in one point vs. a ‘short’ position in another, such that the overall trade has zero net interest rate duration. We focus specifically on curve points that are highly correlated with each other, which typically means they are close to each other.
A notable example this month was AU curve anomalies created by the demand / supply tension between central bank bond buying pinning the 3 year point at 0.25% vs. new government bond supply pushing 4 years rates higher, causing anomalous curve steepness, which subsequently delivered profits as it normalised.
- Inflation Protection
These strategies incurred material losses in the March quarter due to rising pessimism about the global economic growth outlook dampening future inflation expectations. They have now started to recover some of those losses as inflation expectations rebound from highly depressed levels.
As ARO has a dual objective of outperforming both cash and inflation, the portfolio always has a structural inflation protection component, which is implemented using inflation securities (i.e. government inflation linked bonds and inflation swaps). In simplified terms, these inflation securities reflect market expectations of future inflation. When these expectations rise, the prices of these securities also rise, generating profits. This is how ARO protects investor capital against rising inflation risk. The opposite happens when inflation expectations fall.
At current levels we view inflation securities as offering a compelling profit opportunity with favourably asymmetric characteristics (i.e. limited downside risk vs. large profit potential). Further details are available here.
There were no noteworthy negative performers this month.
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Underlying Fund Ratings
__________________________________________________________________________________
Unless otherwise specified, any information contained in this publication is current as at the date of this report and is provided by
Ardea Investment Management Pty Ltd ABN 50 132 902 722 AFSL 329 828 (Ardea), the investment manager of the ActiveX Ardea
Real Outcome Bond Fund (Managed Fund) ARSN 629 403 925 and the Ardea Real Outcome Fund ARSN 158 996 699 (Funds).
Fidante Partners Limited ABN 94 002 835 592 AFSL 234668 (Fidante Partners) is the responsible entity and issuer of interests
in the Funds. The information in this publication should be regarded as general information and not financial product advice, and
has been prepared without taking into account of any person's objectives, financial situation or needs. Because of that, each person
should, before acting on any such information, consider its appropriateness, having regard to their objectives, financial situation
and needs. Each person should obtain and consider the Product Disclosure Statement (PDS) and any additional information booklet
(AIB) for the Fund before deciding whether to acquire or continue to hold an interest in the Fund. A copy of the PDS and any AIB
can be obtained from your financial adviser, our Investor Services team on 13 51 53, or on our website www.fidante.com.au.
Please also refer to the Financial Services Guide on the Fidante Partners website. Past performance is not a reliable indicator of
future performance. Neither your investment nor any particular rate of return is guaranteed. The information contained in this
document is not intended to be relied upon as a forecast and is not a recommendation, offer or solicitation to buy or sell any
securities or to adopt any investment strategy, nor is it investment advice. If you acquire or hold the product, we, Fidante Partners
or a related company will receive fees and other benefits which are generally disclosed in the PDS or other disclosure document
for the Fund. Neither Fidante Partners nor a Fidante Partners related company and its respective employees receive any specific
remuneration for any advice provided to you. However, financial advisers (including some Fidante Partners related companies)
may receive fees or commissions if they provide advice to you or arrange for you to invest in the Fund. Ardea, some or all Fidante
Partners related companies and directors of those companies may benefit from fees, commissions and other benefits received by
another group company.
The Zenith Investment Partners (ABN 27 103 132 672, AFS Licence 226872) (“Zenith”) rating (assigned May 2018) referred to in
this document is limited to “General Advice” (s766B Corporations Act 2001) for Wholesale clients only. This advice has been
prepared without taking into account the objectives, financial situation or needs of any individual and is subject to change at any
time without prior notice. It is not a specific recommendation to purchase, sell or hold the relevant product(s). Investors should
seek independent financial advice before making an investment decision and should consider the appropriateness of this advice
in light of their own objectives, financial situation and needs. Investors should obtain a copy of, and consider the PDS or offer
document before making any decision and refer to the full Zenith Product Assessment available on the Zenith website. Past
performance is not an indication of future performance. Zenith usually charges the product issuer, fund manager or related party
to conduct Product Assessments. Full details regarding Zenith’s methodology, ratings definitions and regulatory compliance are
available on our Product Assessments and at http://www.zenithpartners.com.au/RegulatoryGuidelines
The Lonsec Rating (assigned October 2019 – ActiveX Ardea Real Outcome Bond Fund) presented in this document is published by Lonsec Research Pty Ltd ABN 11 151 658 561 AFSL 421445. The Rating is limited to “General Advice” (as defined in the
Corporations Act 2001 (Cth)) and based solely on consideration of the investment merits of the financial products. Past performance information is for illustrative purposes only and is not indicative of future performance. They are not a
recommendation to purchase, sell or hold Ardea Investment Management products, and you should seek independent financial advice before investing in these products. The Ratings are subject to change without notice and Lonsec assumes no obligation to
update the relevant documents following publication. Lonsec receives a fee from the Fund Manager for researching the products using comprehensive and objective criteria. For further information regarding Lonsec’s Ratings methodology, please refer to our
website at: http://www.lonsecresearch.com.au/research-solutions/our-ratings
CONTACT US
For further information, contact Fidante Partners Investor Services on 13 51 53 or email [email protected]
For investor enquiries, please contact Link Market Services on 1800 441 104 or email
For financial planner enquiries, please contact your local BDM or email [email protected]
www.fidanteactivex.com.au
