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Overview The Schroder Fixed Income Fund is a low volatility defensive fund that invests in a range of domestic and international fixed income assets with the objective of delivering stable absolute returns over time. It adopts a ‘core-plus’ approach whereby a core portfolio comprising Australian bonds is complemented by investments in a diverse range of uncorrelated non-benchmark fixed income securities. Actively managed by Schroders’ experienced fixed income team, investments within the portfolio are rotated in an attempt to ensure we are in the right assets at the right time to maximise return while maintaining a low risk profile. The targeted result is a broadly diversified fixed income portfolio that aims to be less volatile than funds investing only in domestic fixed income securities.
Benefits – Robust investment process and risk management framework with an emphasis on low volatility of returns and targeting competitive risk adjusted returns.
– Diversified and broad investment universe of fixed income securities from which to generate returns.
– Defensive fund with a low correlation to equity markets which provides excellent portfolio diversification benefits.
– Experienced Australian team that is well integrated with Schroders global and regional resources.
Portfolio summary Performance objective To outperform the UBS Composite Index by 1 – 1.5% per annum over the medium term before fees
Tracking error Target 0.5 – 1.5% pa
Style Actively managed
Asset classes Australian hybrid securities, emerging market debt, Asian debt, Australian bonds, international bonds and cash
Derivatives Used for hedging and efficient portfolio management
Investment philosophy and process
Our fixed income investment philosophy is based on our belief that most investors make inefficient use of the opportunity set available to them. For example, such investors may focus too much on arbitrary benchmarks that are not aligned with their objectives or they may have too narrow a focus (i.e. duration or credit). It is our belief that this creates an inefficiency that can be captured by broadening the opportunity set to capture diversified sources of risk and return.
Asset allocationIdentifying what assets to own and when to own them is the most important step in the investment process as it will have the greatest impact on the overall return and risk characteristics of the Fund. This step involves combining our medium term expectations of fixed income asset class risk and return with shorter term views on market valuation, cyclical developments and liquidity considerations, matched against the Fund’s objectives to develop the appropriate asset allocation of the Fund. This step in the process ensures we utilise the broadest opportunity set but actively manage these exposures to ensure we are in the right assets at the right time.
Security selectionSecurity selection within each of the underlying asset classes is carried out in a manner aiming to exploit those areas with the most potential for adding value. The core Australian fixed income exposure is managed on a low risk active basis as we believe the opportunity to add significant value in this asset class is limited. The remaining asset classes are managed by the relevant market specialists within the Schroders group.
SchroderFixed Income Fund
Fund Summary
Investment process (cont.) Portfolio constructionPortfolio construction and risk management are the final important steps in the process. The portfolio structure at any point in time is a result of a disciplined analytical evaluation combined with our experience and judgement. The risk of the total portfolio is monitored on a continuous basis to ensure that the risks are appropriate in light of the expected returns and the Fund objective.
Asset allocation Security selection Portfolio construction
What are the risks? All investments involve risks however Schroders actively re-assesses and manages risk at every stage of the investment process. The main risks specifically with investing in this Fund are market risk, fixed interest and debt securities risk, derivatives risk and risks associated with international investing such as movements in exchange rates. For further details about the risks of investing in this Fund please refer to the Product Disclosure Statement.
Fund features Fund inception date February 2004
Valuation Every business day
Minimum investment $50,000
Buy/sell spread 0.12% on application; 0.12% on redemption
Entry/exit fees Nil
Management costs 0.50% pa
Distributions Last business day of March, June, September and December
Contact detailsRay MackenHead of [email protected] Ph: 02 9210 9330 Mob: 0414 300 796
Mardi Hall (NSW)Deputy Head of Retail [email protected]: 02 9210 9318 Mob: 0403 040 565
Chris BoydResearch & Key Account [email protected]: 02 9210 9259Mob: 0416 077 166
Bob Holloway (NSW/WA)Key Account [email protected]: 02 9210 9260 Mob: 0414 930 013
David Burke (QLD/NSW)Business Development [email protected]: 02 9210 9256 Mob: 0403 106 377
Jude Fernandez (VIC/TAS/NSW)Business Development [email protected]: 02 9210 9312 Mob: 0414 604 772
Jasmine del Villar (NSW/SA/ACT)Business Development [email protected] Ph: 02 9210 9313 Mob: 0401 576 385
Lisa Hamilton Business Development Manager, Platforms [email protected] Ph: 02 9210 9316 Mob: 0410 564 775
Adviser Services Team: 1300 136 471
Disclaimer: Investment in the Schroder Fixed Income Fund may be made on an application form in the Schroder Wholesale Series Product Disclosure Statement dated 1 February 2011 which is available from Schroder Investment Management Australia Ltd (ABN 22 000 443 274, AFS Licence 226473). Total returns are calculated using exit price to exit price, after fees and expenses, and assuming reinvestment of income. The repayment of capital and performance of the Fund is not guaranteed by Schroders or any other party. Past performance is not necessarily a guide to future performance. Unless otherwise stated the source for all graphs and tables contained in this report is Schroders. Opinions constitute our judgement at the time of issue and are subject to change. Investment guidelines are internal only and are subject to change without notice. This fund summary does not contain and is not to be taken as containing any securities advice or securities recommendation. For security reasons telephone calls may be taped. May 2012 SC870
Schroder Fixed Income Fund
Fund Summary
mthly qtr 1 year 3 year 5 year Incpt
Total return % 1 mth 3 mths 1 yr 3 yrs p.a. 5 yrs p.a. Inception p.a.
0.89 1.56 3.56 7.06 6.55 6.64
1.09 1.52 3.33 7.01 5.64 6.32
-0.20 0.04 0.23 0.05 0.91 0.32
0.94 1.69 4.08 7.59 7.09 7.16
Past performance is not a reliable indicator of future performance
Portfolio inception 25/02/2004, 9 years and 11 months Please refer to www.schroders.com for post-tax returns
Asset allocation % Market review
Portfolio Benchmark Portfolio reviewModified duration 3.28 yrs 4.14 yrs
Yield to maturity 3.90% 3.52%
Average credit rating A AA
Number of securities 648 457
Sector exposure %
Outlook and strategy
*The 'Portfolio' is the Schroder Fixed Income Fund
*Unless otherwise stated figures are as at the end of Jan 2014
*Benchmark is the UBSA Composite Bond Index
*Please note numbers may not total 100 due to rounding
*The cash and credit exposure as shown in the 'Asset allocation' and
'Sector exposure' charts may be different due to the difference in treatment
of our CDX position; the former is reported on an effective exposure basis
and the latter only captures the current profit and loss of the position.
January 2014 Monthly Report
Schroder Fixed Income Fund
Schroder Fixed Income Fund (post-fee)
UBSA Composite Bond Index
Relative performance (post-fee)
Schroder Fixed Income Fund (pre-fee)
Portfolio statistics
*The Portfolio may have a sizeable exposure to securities, including cash
instruments, issued by each of the four major Australian banks.
The month of January was dominated by capital flight out of emerging markets, which was triggered by concerns about the outlook for China and Fed "tapering". Weak Chinese manufacturing data and news that a high yield investment trust (curiously named "Credit equals Gold No. 1") was on the brink of default, although it was subsequently bailed out, saw investors worry about the financial underpinning of the Chinese economy. This was combined with the US Federal Reserve's decision to continue to "taper", reducing its monthly bond purchases by a further $US10bn to $US65bn. This decision was unanimous, the first time there has been no dissent since the policy meeting in June 2011. These factors led to capital flight, impacting negatively on emerging market currencies and equity markets. Pressure on exchange rates saw Argentina's central bank step back from supporting its currency, seeing the Argentine Peso drop by 15% in a day, and hikes of official cash rates in Brazil, India, South Africa, and Turkey. In Turkey's case, cash rates were doubled in a midnight decision. Troubles in emerging markets spread widely with risk assets falling and safe havens performing strongly. The safe haven status of government bonds saw strong inflows, leading to falls in yields. US 10 year government bond yields fell by 0.38%, ending the month at 2.64%, while Japan and German 10 year yields ended the month 0.12% and 0.27% lower respectively. The Australian bond market followed this trend, with 10 year government bond yields falling by 0.24% to 4.00%. Credit markets performed relatively well given the environment, with both higher yielding and investment grade bonds posting small positive gains. As is customary, there was no meeting of the Reserve Bank of Australia's board in January.
January's market volatility again highlighted the challenges that lie ahead for investors. At the top of this list is the delicate balance between policy settings, the economy and markets. Nowhere is this more evident than in the US, where the Fed (now under Janet Yellen's chairmanship) appears sufficiently comfortable with the extent and breadth of the US economic recovery to continue a modest and well telegraphed retreat from QE. However the implicit caveat in this retreat is that should the recovery fade or asset process collapse they will halt their withdrawal and potentially provide additional support to the market (again underwriting risk). Australia has its own challenges. The economy is in the throes of a structural economic adjustment with limited policy flexibility to respond. Fiscal policy is constrained by the deterioration in the budget position, and while policy makers (and industry generally) would prefer a weaker exchange rate - short of massive intervention, there is little they can really do to push the exchange rate down. The burden therefore falls to monetary policy to provide the support. For markets this has several implications. Risk assets continue to be supported by cheap money and implicit central bank support. This works when risk assets are cheap, but is less compelling as valuations deteriorate and the proximity to an eventual "tightening" of policy nears. Valuations ultimately matter, no matter how much fuel gets thrown on the fire. Likewise sovereign bonds remain expensive due in part to policy actions. While fair value implies higher yields it also requires a normal policy environment (or certainly an expectation that normalisation is coming) to facilitate. While normality still seems some way off, the expectation of normality may not be as far away and market thinking can change quickly. Paying too much attention to what the Fed says could be dangerous. In terms of positioning, we do not see the volatility in January as being sufficient to change our thinking or positioning. The best value is arguably in the term premium implied by steep yield curves. Credit spreads (and spreads on "spread type assets such as semi's) have narrowed but are not extreme. Overall returns from the Portfolio are likely to remain modest.
Australian Bonds, 69.0%
Cash & Equivalents,
21.4%
Australian Higher
Yielding Credit, 3.6%
International Bonds, 6.0%
0.0% 10.0% 20.0% 30.0% 40.0%
Supranational/ Sovereign
Semi-Government
Hybrids
Government
Corporates
Collateralized
Cash &Equivalents
Portfolio Benchmark
While solid returns from bonds have been hard to come by of late, January reminded investors just why they invest in fixed income with positive returns from bonds significantly outperforming equities which retreated during the month. The Portfolio returned 0.89% in January (post fees) resulting in a 1 year return of 3.56% (post fees). The January result was slightly below the benchmark UBS Composite Bond Index. The Portfolio's performance versus its benchmark reflected the Portfolio's overall short duration position together with a continuing (albeit significantly reduced) overweight to credit. This was offset by flatter yield curves in Australia and the US where we have established a curve flattening bias given the very steep yield curves prevailing in these markets. While we have been actively managing the size and composition of our duration positioning, we remain short (in the US and to a lesser extent Germany). We have continued to trim credit (albeit we remain effectively overweight credit) and on a sector level the strong performance of semi-government bonds has lessened their attractiveness.
Top ten holdings % Portfolio
NSW Treasury Corp (AUD 6.000, 1/3/2022) 4.1
QLD Treasury Corp (AUD 6.000, 21/7/2022) 3.8
QLD Treasury Corp (AUD 5.500, 21/6/2021) 3.4
Australian Commonwealth (AUD 5.500, 21/1/2018) 2.9
Western Aust Treas Corp (AUD 7.000, 15/7/2021) 2.3
NSW Treasury Corp (AUD 6.000, 1/2/2018) 2.0
QLD Treasury Corp (AUD 6.000, 14/9/2017) 1.9
QLD Treasury Corp (AUD 6.250, 21/2/2020) 1.7
Westpac Banking Corp (AUD 5.250, 21/11/2023) 1.4
Treasury Corp Of Victoria (AUD 5.500, 15/11/2018) 1.3
Total 24.9
Maturity profile % Portfolio Benchmark
0-3 Years 38.7 33.0
3-5 Years 20.7 22.3
5-7 Years 10.6 16.7
7-10 Years 20.7 19.0
10 Years + 9.4 9.0
Security profile % Portfolio Benchmark
Fixed rate 67.5 100.0
Floating rate 32.5 0.0
Other 0.0 0.0
Regional exposure % Portfolio Benchmark
Australia 90.7 100.0
USA 6.4 0.0
Europe ex UK 2.0 0.0
UK 0.9 0.0
Asia inc Japan ex EM 0.0 0.0
Emerging Markets 0.0 0.0
Fund details
Schroder Fixed Income Fund Holdings by composite broad credit rating % Portfolio Benchmark
APIR code SCH0028AU AAA 41.7 71.3
Fund size (AUD) AA 17.2 21.3
Redemption unit price $1.1016 A 8.9 5.3
Fund inception date BBB 10.9 2.1
Buy / sell spread 0.12%/0.12% BB 0.9 0.0
Management costs 0.50% B 0.1 0.0
Minimum initial investment $50,000 CCC and below 0.0 0.0
Distribution frequency Normally quarterly Cash 20.2 0.0
Not Rated 0.0 0.0
Unless otherwise stated figures are as at the end of January 2014
Figures may not total 100 due to rounding
Regional exposure is expressed by currency pre-hedging.
Contact
www.schroders.com.au
E-mail: [email protected]
Schroder Investment Management Australia Limited
ABN 22 000 443 274 Australian Financial Services Licence 226473
Level 20 Angel Place, 123 Pitt Street, Sydney NSW 2000
Phone: 1300 136 471 Fax: (02) 9231 1119
February-2004
Investment in the Schroder Fixed Income Fund (“the Fund“) may be made on an application form in the Product Disclosure Statement dated 1 February 2011, available from Schroder Investment
Management Australia Limited (ABN 22 000 443 274, AFSL 226473) (“Schroders”).
Schroder Fixed Income FundMonthly ReportJanuary 2014
$2,144,485,960
This Report is intended solely for the information of the person to whom it is provided by Schroders. It should not be relied on by any person for the purposes of making investment decisions. Total returns are calculated using exit price to exit price, after fees and expenses, and assuming reinvestment of income. Gross returns are calculated using exit price to exit price and are gross of fees and expenses. The repayment of capital and performance of the Fund is not guaranteed by Schroders or any company in the Schroders Group. Past performance is not a reliable indicator of future performance. Unless otherwise stated the source for all graphs and tables contained in this report is Schroders. Opinions constitute our judgment at the time of issue and are subject to change. This report does not contain and is not to be taken as containing any financial product advice or financial product recommendation. For security reasons telephone calls may be recorded.This Report is intended solely for the information of Wholesale Investors as defined under the Corporations Act. You agree not to pass on any credit rating and/or related research to a party who is not a Wholesale Investor.
Fund Objective To obtain exposure to a diversified range of domestic and international fixed income securities with the principal aim of outperforming the UBS Composite Bond Index after fees over the medium term.
Investment style Our broad fixed income philosophy is underpinned by 3 key ideas: – Fixed income is typically held for defensive purposes. These include liquidity, capital preservation, liability management and to diversify equity risk. – Investors should utilise the breadth of the fixed income universe to improve risk / return outcomes (as opposed to closely tracking arbitrary benchmarks). – Volatility is not risk; we view losing money and not delivering on objectives as our core risk. These key investment beliefs are encapsulated in our Schroder Fixed Income Fund, a Core-Plus strategy which combines a low active risk ‘Core’ and ‘Plus’ strategies where opportunities to add value is present. The Portfolio utilises the breadth of the opportunity set and combines asset allocation, country selection, credit risk management, stock selection, and duration/yield curve in a combination that aims to outperform the benchmark UBS Composite Bond Index over the medium term whilst ensuring it remains a true defensive strategy.
September 2013 For professional investors only
Issued by Schroder Investment Management Australia Limited
123 Pitt Street Sydney NSW 2000ABN 22 000 443 274 Australian Financial Services Licence 226473
The Fix Fixed income…anything but!
by Simon Doyle, Head of Fixed Income and Multi-Asset Executive summary The last 3 months have been a difficult time for bond investors. Accumulating evidence of a recovery in the US economy prompting the US Federal Reserve to declare that “tapering” of the existing QE program would likely commence before year end was the catalyst. US 10 year bond yields have subsequently risen from 1.6% to 3.0%, while Australian 10 year bond yields have risen from 3% to over 4% over the equivalent timeframe despite broad based signs of domestic economic weakness. The reality of this sharp rise in yields for most fixed income investors has been lower returns (at least in the short run), albeit higher yields improve the medium term outlook. While we have been arguing for some time that for a variety of reasons bond yields were unsustainably low, we think it timely to revisit the challenges this current difficult environment poses for investors – whether they hold fixed income investments or not. In this article we: revisit the rationale for holding fixed income investments; highlight the implications of rising bond yields for portfolio returns; discuss how uncertain the outlook for bond yields remains (despite the consensus view); and discuss the implications for investors in the context of the broader investment portfolios, in
particular the idea that the strategies investors are considering to overcome these issues may end up causing investors the opposite results to those intended.
Why hold fixed income? Given the difficulties in forecasting market returns (particularly in the short run) it is fundamentally important that investors have a clear understanding of the role they expect all assets to play in their portfolios and under what circumstances they expect each asset to deliver. This means that assets have the time to perform and are not discarded simply because short run returns are not up to par. A necessary condition of a well constructed portfolio is divergent performance, even if at times this means some assets (even fixed income) will be generating negative returns. The role of fixed income in its various guises is relatively easy to define. Investors typically hold fixed income assets for one or more of the following reasons: to provide income; to match a particular liability stream (in the case of individual investors this may simply be
income requirements); to preserve capital; and to diversify away risk from equities and other so called “risky” assets.
What’s notable here is what’s not on the list. Investors rarely hold fixed income assets as a growth driver or as the primary driver of high returns in their portfolios. This means (in theory at least) that investors should be less sensitive to the quantum of the returns generated from their fixed income investments, but more sensitive to the ability of these investments to satisfy their objectives listed above (i.e. in particular the provision of income and the diversification of equity risk). As a consequence, one way of looking at the relevance of a fixed income position is from the perspective of its ability to satisfy these criteria in a portfolio context – not by the quantum of returns. This is particularly important at the current time as investors look at the progressive reduction in
September 2013 For professional advisers only
Schroder Investment Management Australia Limited 2
returns from their defensive assets, see potentially negative returns over short run periods and question their perception of the future merits of holding fixed income in their portfolios. Clearly, the structural shift lower in interest rates emanating from weak underlying global growth and policy support (via QE and alternative programs in Europe and Japan) has had the effect of pulling forward “future” returns accruing to bond investors. This also means that actual “future” returns will necessarily be lower, given lower underlying yields, and the proximity of bonds to the zero lower bound. How long this lasts depends on how far and how quickly bonds yields reprice (and the various risk premiums associated with fixed income i.e. term risk, credit risk, liquidity risk and structural risk are re-built). Figure 1: UBS Composite Bond Index Annual Returns
The impact of rising yields Those with long memories will recall the bond market sell off of 1994, while those with less history to reference are likely to be tarnished by those who do. Figure 2: 1994 revisited
-5.0%
0.0%
5.0%
10.0%
15.0%
20.0%
Calendar Year Returns - UBS Composite Bond Index
Source: UBS, Datastream. To end July 2013
0
2
4
6
8
10
12
14
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
Per
cen
t
Australian 10 Year Government Bond Yields
Source: Datastream, Schroders
September 2013 For professional advisers only
Schroder Investment Management Australia Limited 3
There are several things that stand out about 1994. The sell-off, while significant (Australian 10 year bond yields rose by over 4%), was over in
around 8 months; Bonds actually outperformed equities in 19941; The sell-off came in the middle off a sustained bull market in bonds (as the disinflationary cycle
was still well underway) and set up a terrific buying opportunity; Those investors that held their positions, did very well on a 2 or 3 year timeframe2 (see Figure 1
above);
While there are limitations to how far we can extend the parallels, particularly as the secular dis-inflationary trend seems to have largely run its course, it does highlight that the degree of concern about a 1994 repeat may be overdone. One reason for this is analysis typically references movements in the 10 year bond yield exaggerating the likely impact on investor returns given its relatively long duration. Figure 3: The impact of rising bond yields on bond returns.
Figure 3 shows the returns accruing to bond investors holding portfolios of differing durations for varying increases in bond yields. The key variables in this analysis are duration and the extent of the move in yields. With duration effectively representing the sensitivity of the investment to changes in rates, as duration increases changes in yields have a materially greater impact. This is an important dimension of fixed income as it means not all bonds (or bond portfolios) are equal when it comes to their sensitivity to changes in yields.
1 In 1994 the UBS Composite Bond Index returned -4.7% vs -8.8% for the ASX 200 Accumulation Index 2 The 3 year return to end 1996 on UBS Composite Bond Index was 8.2% p.a. compared with 8.1%p.a. for the ASX 200 Accumulation Index.
-30%
-25%
-20%
-15%
-10%
-5%
0%
5%0 1 2 3 4 5 6 7 8
1 Y
ear
Ret
urn
Duration (yrs)
Bond returns following rising yields for different portfolio durations
1% Rise in Yields over 1 Yr 2% Rise in Yields over 1 yr
3% Rise in Yields over 1 Yr 4% Rise in Yields over 1 yr
Source: Bloomberg/Schroders. Based on Australian CGS yield curve as at 26 August 2013. For SFIF, calculation is duration only and doesn't include offsets from other investments such as credit.
10 Year Bond
SFIF
UBS Composite
September 2013 For professional advisers only
Schroder Investment Management Australia Limited 4
While the market “benchmark” is typically the 10 year government bond, investors rarely hold 10 year bonds as the entirety of their fixed income portfolio, in part because 10 year bonds are a relatively long duration investment (the benchmark 10 year bond in Australia has a duration of 7.5 years). Drawing a parallel with equities, it’s a similar situation to basing a view on equities with the performance of the riskiest stocks, not to that of the investor’s portfolio exposure. More typically, investors will hold either an index portfolio (with a duration closer to 4 years), or an active portfolio which may have a duration signficantly lower (the Schroder Fixed Income Fund has duration currently of around 3 years). Clearly the shorter the duration, the more moderate the impact on returns if yields rise. The flip side of this is to consider what would happen to other asset classes (i.e. equities) if yields were to rise as indicated under each of these scenarios. Given current valuations for equities aren’t cheap, we would expect equities to be coming under more pressure than bonds. The outlook is far from certain What’s less clear is how far yields need to rise or indeed whether they rise at all. The recent rise in yields has given bond yields some breathing room, however, in a structural sense “fair-value” is in our view still some way from current yields. Our simple structural “fair value” model for US 10 year bond yields, which is effectively a function of real yields and inflation expectations suggests “fair value” at around 4% (assuming 2% real growth, or more correctly potential GDP and 2% inflation expectations). However, the fragility of the US recovery (particularly given evidence that higher bond yields may already be crimping demand) could mean real yields remain lower than this. As a consequence this may in fact facilitate a reduction in inflation expectations, lowering equilibrium “fair value”. Furthermore, the re-emergence of recession (fear or reality) could push bond yields lower again. In fact, there is no guarantee that bond yields will rise signficantly from here (despite this being the consensus view). Under this scenario, were bond yields to decline and revisit previous lows, bond returns would likely signficantly outperform equities (in both relative and absolute terms). The point here is simply that despite low yields from an historical persective, the uncertainty around the global economy and financial markets means fixed income remains an important component of a well constructed portfolio. While low yields may impact on the ability of fixed income to hedge equity risk, it doesn’t remove it. Furthermore, if deflation were to emerge, then bonds would signficantly outperform equities, both in nominal and real terms, making them a valuable component of the portfolio. Portfolio construction considerations In my comments above I argued that investors hold fixed income in their portfolios for predominantly defensive reasons. This is particularly important in the current “low yield” environment where investors are grappling with the portfolio construction decision in an environment of historically low yields and relatively low spreads across the risk spectrum (ie. credit, liquidity and structural). Against this backdrop the pressure to boosts yields and raise returns is heightened, fuelling a temptation to move out along the risk curve to achieve these goals. This is, in our view, a dangerous strategy and one which is likely to achieve the opposite result to that intended. There are several reasons for this. Low yields have also compressed risk premia more broadly, meaning that the additional risk
premia that investors may access (especially with regards to credit) is expensive. Buying expensive assets adds significantly to risk.
Consistent with the point above, adding risk to a “defensive” strategy significantly reduces the ability of that component of the portfolio to do its job. Investors only need to look back to 2008 for a case study on how increasing risk in defensive strategies to boost returns can have catastrophic consequences on investment outcomes.
September 2013 For professional advisers only
Schroder Investment Management Australia Limited 5
In our view there are several other ways to approach the problem of low yields in a portfolio construction context. If fixed income is predominantly held for defensive reasons (namely to diversify equity risk) and
its ability to be as effective as it has been historically has been compromised by low yields, then investors should actually look to cut their equity (or risk) exposure – not increase it.
Adopting an active approach to fixed income that utilises the breadth of the asset class may also significantly improve the outcome to the investor. This extends to active duration management, but not in the context of small tweaks to duration positioning, but rather to assessing how much duration is appropriate given broader portfolio objectives and targeting this, as well as utilising the low correlations between duration and credit to mitigate the risk of either3.
Being patient. Returns will be dictated by market pricing. Forcing risk into the portfolio to boost returns risks exactly the opposite outcomes investors intended. In this context investors should not underestimate the value of cash (even at very low cash rates) as this asset class has the benefits of ensuring liquidity, preserving capital and providing a platform to add risk (or duration) when it makes sense to do so.
In summary It is important to consider fixed income investments from the perspective of the role they play in
a portfolio, rather than on the basis of short run return expectations. While a compelling case can be made for yields to rise further and crimp investor returns, it is far
from certain that this scenario will unfold. The exposure investors have to rising rates is typically much less than what the focus on
benchmark (10 year) yields would imply. There is no easy solution to the challenge of low yields. Taking more risk to boost returns risks
generating the opposite result to that intended, particularly if the risk being taken is disproporational and expensive. Investors should actually consider reducing their risk/equity exposure in these circumstances.
As unappealing as it sounds, patience and cash will likely combine to provide investors with some excellent opportunities to buy appropriate assets at attractive prices over the period ahead.
End note In my experience, fixed income and its characteristics are not well understood, particularly by unsophisticated investors (and a few sophisticated ones as well). In contrast equities, and their associated volatility is typically appreciated and factored into investor thinking. Part of the problem with fixed income is the diverse nature of the asset class which can manifest itself in extremely divergent outcomes for investors depending on what fixed income assets they own and the characteristics that these assets possess. The name “fixed income” is also problematic as it anchors investor expectations around a consistent (or fixed) rate of return, and a return that is implicitly positive. A more balanced view of the asset class may be achieved if instead we think of fixed income as “debt” and view investments in debt instruments for what they really are, primarily loans to governments, semi-government authorities and corporates over differing time frames with differing conditions attached (ie. fixed rate, floating rate). A more appropriate naming convention may better frame the risks around the asset class and lead to more balanced portfolio decisions. Just a thought ….! 3 For example, in the Schroder Fixed Income Fund, duration is currently around 1 yr shorter than that of the UBS Composite Bond index at approximately 3years. Around 25% of the Fund’s assets are in cash and we hold a diversified mix of high quality corporate bonds, semi-government bonds and instruments such as AAA rated mortgages. This combination mitigates the impact of duration on Fund performance.
September 2013 For professional advisers only
Schroder Investment Management Australia Limited 6
Disclaimer
Opinions, estimates and projections in this article constitute the current judgement of the author as of the date of this article. They do not necessarily reflect the opinions of Schroder Investment Management Australia Limited, ABN 22 000 443 274, AFS Licence 226473 ("Schroders") or any member of the Schroders Group and are subject to change without notice. In preparing this document, we have relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources or which was otherwise reviewed by us. Schroders does not give any warranty as to the accuracy, reliability or completeness of information which is contained in this article. Except insofar as liability under any statute cannot be excluded, Schroders and its directors, employees, consultants or any company in the Schroders Group do not accept any liability (whether arising in contract, in tort or negligence or otherwise) for any error or omission in this article or for any resulting loss or damage (whether direct, indirect, consequential or otherwise) suffered by the recipient of this article or any other person. This document does not contain, and should not be relied on as containing any investment, accounting, legal or tax advice.
Overview The Schroder Credit Securities Fund invests in a range of domestic and international credit and debt securities. The Fund has an absolute return focus with an objective to outperform cash over the medium term after fees whilst minimising capital volatility. Actively managed by Schroders’ experienced fixed income team, investments within the portfolio are dynamically managed with the aim to ensure we are in the right assets at the right time to maximise return with lowest achievable risk.
Benefits – Absolute return focus with an objective to outperform cash and minimise capital volatility.
– Well diversified portfolio of credit and other income securities.
– Dynamic investment process that aims to ensure we are in the right assets at the right time.
– Focus on risk adjusted returns where there needs to be appropriate reward for risk taken and the flexibility to be very defensive.
– Strong domestic and global team, giving investors access to a broader opportunity set and the resources to analyse and monitor credit risk.
Portfolio summary Performance objective To outperform the RBA Cash Rate after fees and deliver income through investment in credit and debt securities with a focus on preserving investor capital
Style Actively managed
No. securities > 300
Derivatives Used for hedging and efficient portfolio management
Asset classesInvestment grade securities, hybrids and subordinated securities, sub-investment grade securities, developing market debt, securitised assets and cash.
Investment philosophy and process
A well constructed portfolio should be forward looking, well diversified, and seek to maximise returns through the cycle by allocating risk efficiently. The Fund’s objectives are achieved through accessing the risk premia across a range of Australian and global fixed income markets (typically credit) and actively managing the exposure between these.
Fundamental to our philosophy is ensuring investors are being properly rewarded for the risks they are taking. The risk management process has the flexibility to reduce market exposure when risk premiums are not justifiably sufficient to reward the investor. Given the breadth of the opportunity set, it is important to have an investment process which rotates across strategies to allow us to be in the right assets at the right time.
The practical application of our philosophy involves separating the investment process into several key steps with the aim to achieve higher absolute returns at lower risk than traditional credit funds:
Asset allocationIdentifying what assets to own and when to own them is the most important step in the investment process as it will have the greatest impact on the overall return and risk characteristics of the Fund. This step involves combining our medium term expectations of fixed income asset class risk and return with shorter term views on market valuation, cyclical developments and liquidity considerations, matched against the Fund’s objectives to develop the appropriate asset allocation of the Fund. This step in the process ensures we utilise the broadest opportunity set but actively manage these exposures to ensure we are in the right assets at the right time.
SchroderCredit Securities Fund (formerly known as the Schroder Hybrid Securities Fund)
Fund Summary
Investment process (cont.) Security selectionSecurity selection is the next step. Security selection within each of the underlying asset classes is carried out in a manner aiming to exploit those areas with the most potential for adding value. The Australian credit exposure is actively managed to avoid defaults as we believe stock selection, sector selection and managing credit exposure present significant opportunities to add value. The remaining strategies are managed by the relevant market specialists within the Schroders Group.
Portfolio constructionPortfolio construction and risk management is the final important step in the process. The portfolio structure at any point in time is a result of a disciplined analytical evaluation combined with our experience and judgement. The risk of the total portfolio is monitored on a continuous basis to ensure that the risks are appropriate in light of the expected returns and the Fund objective.
Asset allocation Security selection Portfolio construction
What are the risks All investments involve risks however Schroders actively re-assesses and manages risk at every stage of the investment process. The main risks specifically with investing in this Fund are market risk, fixed interest and debt securities risk, derivatives risk and risks associated with international investing such as movements in exchange rates. For further details about the risks of investing in this Fund please refer to the Product Disclosure Statement.
Fund features Fund inception date August 2002
Valuation Every business day
Minimum investment $50,000
Buy/sell spread 0.15% on application; 0.15% on redemption
Entry/exit fees Nil
Management costs 0.75% pa
Distributions Last business day of March, June, September and December
Contact detailsRay MackenHead of [email protected] Ph: 02 9210 9330 Mob: 0414 300 796
Mardi Hall (NSW)Deputy Head of Retail [email protected]: 02 9210 9318 Mob: 0403 040 565
Chris Boyd (Researchers & WA)National Account [email protected] Ph: 02 9210 9259 Mob: 0416 077 166
David Burke (QLD/NSW)National Account Manager [email protected]: 02 9210 9256 Mob: 0403 106 377
Jude Fernandez (VIC/TAS)National Account Manager [email protected]: 02 9210 9312 Mob: 0414 604 772
Jasmine del Villar (NSW/SA/ACT)National Account Manager [email protected] Ph: 02 9210 9313 Mob: 0401 576 385
Lisa Hamilton (Platform)National Account Manager [email protected]: 02 9210 9316 Mob: 0410 564 775
Daniel Connell (VIC/NSW)Business Development Manager [email protected]: 02 9210 9352 Mob: 0414 385 968
Adviser Services Team: 1300 136 471
Disclaimer: Investment in the Schroder Credit Securities Fund may be made on an application form in the Schroder Wholesale Series Product Disclosure Statement dated 1 February 2011 which is available from Schroder Investment Management Australia Ltd (ABN 22 000 443 274, AFS Licence 226473). Total returns are calculated using exit price to exit price, after fees and expenses, and assuming reinvestment of income. The repayment of capital and performance of the Fund is not guaranteed by Schroders or any other party. Past performance is not necessarily a guide to future performance. Unless otherwise stated the source for all graphs and tables contained in this report is Schroders. Opinions constitute our judgement at the time of issue and are subject to change. Investment guidelines are internal only and are subject to change without notice. This fund summary does not contain and is not to be taken as containing any securities advice or securities recommendation. For security purposes telephone calls may be taped. January 2013 SC895
Schroder Credit Securities Fund
Fund Summary
mthly qtr 1 year 3 year 5 year 10 year
Total return % 1 mth 3 mths 1 yr 3 yrs p.a. 5 yrs p.a. 10 yrs p.a.
0.24 1.24 4.60 5.88 9.68 5.64
0.21 0.62 2.70 3.64 3.74 4.41
0.03 0.62 1.90 2.24 5.94 1.23
0.31 1.43 5.38 6.67 10.51 6.44
Past performance is not a reliable indicator of future performance
Portfolio inception 23/08/2002, 11 years and 5 months Please refer to www.schroders.com for post-tax returns
Asset allocation % Market review
Portfolio review
Modified duration 0.40 yrs
Yield to maturity 4.71%
Average credit rating BBB
Number of securities 1098
Sector exposure %Asset Allocation
Banks 44.5
Diversified financial 9.8
Insurance 4.8
Real Estate 2.7
REITS 2.4
Investment companies 0.0Government 6.2 Outlook and strategyConsumer, Non-cyclical 5.2
Industrial 4.7
Utilities 3.9
Consumer, Cyclical 3.8
Communications 3.4
Energy 3.2
Other 3.0
Basic Materials 1.6
Diversified 0.5
Technology 0.5
*The 'Portfolio' is the Schroder Credit Securities Fund
*Unless otherwise stated figures are as at the end of Jan 2014
*Benchmark is the RBA Cash Rate
*Please note numbers may not total 100 due to rounding
Relative performance (post-fee)
January 2014 Monthly Report
Schroder Credit Securities Fund
Schroder Credit Securities Fund (post-fee)
RBA Cash Rate
Schroder Credit Securities Fund (pre-fee)
*5 years and 10 years returns are based on a blend of RBA Cash Rate and UBSA Credit Index.
Portfolio statistics
*The Portfolio may have a sizeable exposure to securities, including cash
instruments, issued by each of the four major Australian banks.
Fin
ancia
ls
The month of January was dominated by capital flight out of emerging markets, which was triggered by concerns about the outlook for China and Fed "tapering". Weak Chinese manufacturing data and news that a high yield investment trust (curiously named "Credit equals Gold No. 1") was on the brink of default, although it was subsequently bailed out, saw investors worry about the financial underpinning of the Chinese economy. This was combined with the US Federal Reserve's decision to continue to "taper", reducing its monthly bond purchases by a further $US10bn to $US65bn. This decision was unanimous, the first time there has been no dissent since the policy meeting in June 2011. These factors led to capital flight, impacting negatively on emerging market currencies and equity markets. Pressure on exchange rates saw Argentina's central bank step back from supporting its currency, seeing the Argentine Peso drop by 15% in a day, and hikes of official cash rates in Brazil, India, South Africa, and Turkey. In Turkey's case, cash rates were doubled in a midnight decision. Troubles in emerging markets spread widely with risk assets falling and safe havens performing strongly. The safe haven status of government bonds saw strong inflows, leading to falls in yields. US 10 year government bond yields fell by 0.38%, ending the month at 2.64%, while Japan and German 10 year yields ended the month 0.12% and 0.27% lower respectively. The Australian bond market followed this trend, with 10 year government bond yields falling by 0.24% to 4.00%. Credit markets performed relatively well given the environment, with both higher yielding and investment grade bonds posting small positive gains. As is customary, there was no meeting of the Reserve Bank of Australia's board in January.
Australian Bonds, 41.5%
Hybrids and Convertibles,
16.3%
Cash & Equivalents,
23.8%
International Bonds, 14.1%
Global High Yield, 4.3%
The Portfolio returned 0.24% (post-fee) over the month versus cash of 0.21%. This brings the twelve month return to 4.60% (post fee) or 1.90% over the cash rate. Despite risk assets coming under pressure over the month, credit assets posted moderate gains across the board. Investment grade outperformed sub-investment grade whilst the small long duration position in Australia of close to 0.7 years also provided some support to the Portfolio. Sector positioning remained broadly unchanged over the month as we continue to favour sectors and issuers that have higher quality balance sheets and more stable and predictable cash flows. We are also favouring the senior points on the capital structure as the search for yield has driven down the subordination risk premium demanded by investors. In terms of individual exposures the senior unsecured note issued by Asciano was a positive contributor to performance in January. Asciano commenced 2014 by securing the renewal of a rail haulage agreement with Whitehaven Coal out to 2026 which will provide improved fleet utilisation. Overall, Asciano continues to expect FY14 earnings to be ahead of FY13 reflecting commencement of new coal haulage contracts. The senior unsecured listed retail note issued by Primary Health Care was a negative contributor to the Portfolios performance in January. This was largely a consolidation in pricing after the bond had rallied strongly into the last few months of 2013. The note now has just over one and a half years until its maturity and the company has successfully obtained lower cost bank funding that it will use to repay this note in 2015.
January's market volatility again highlighted the challenges that lie ahead for investors. At the top of this list is the delicate balance between policy settings, the economy and markets. Nowhere is this more evident than in the US, where the Fed (now under Janet Yellen's chairmanship) appears sufficiently comfortable with the extent and breadth of the US economic recovery to continue a modest and well telegraphed retreat from QE. However the implicit caveat in this retreat is that should the recovery fade or asset process collapse they will halt their withdrawal and potentially provide additional support to the market (again underwriting risk). Australia has its own challenges. The economy is in the throes of a structural economic adjustment with limited policy flexibility to respond. Fiscal policy is constrained by the deterioration in the budget position, and while policy makers (and industry generally) would prefer a weaker exchange rate - short of massive intervention, there is little they can really do to push the exchange rate down. The burden therefore falls to monetary policy to provide the support. For markets this has several implications. Risk assets continue to be supported by cheap money and implicit central bank support. This works when risk assets are cheap, but is less compelling as valuations deteriorate and the proximity to an eventual "tightening" of policy nears. Valuations ultimately matter, no matter how much fuel gets thrown on the fire. Likewise sovereign bonds remain expensive due in part to policy actions. While fair value implies higher yields it also requires a normal policy environment (or certainly an expectation that normalisation is coming) to facilitate. While normality still seems some way off, the expectation of normality may not be as far away and market thinking can change quickly. Paying too much attention to what the Fed says could be dangerous. In terms of positioning, we do not see the volatility in January as being sufficient to change our thinking or positioning. Credit spreads (and spreads on "spread type” assets such as semi's) have narrowed but are not extreme. Portfolio liquidity remains elevated given our cash holdings. We remain comfortable with our current holdings however should we see the credit risk premium continue to compress we will continue to reduce risk.
Top ten holdings %
QLD Treasury Corp (AUD 6.000, 21/7/2022) 1.5
Term Deposits - Bank of QLD - 18/3/2014 1.4
ANZ Banking Group Ltd (EUR 0.937, 15/12/2053) 1.3
National Australia Bank NCD 07/04/2014 1.1
Westpac Banking Corp NCD 08/04/2014 1.1
National Australia Bank Ltd (EUR 1.244, Perpetual) 1.1
Swiss Reinsurance Co Ltd (AUD 3.775, Perpetual) 1.1
Westpac Banking Corp NCD 06/02/2014 1.1
Westpac Banking Corp (USD 3.625, 28/2/2023) 1.0
Insurance Australia Grp (AUD 6.588, Perpetual) 1.0
Total 11.8
Maturity profile %
0-1 years 30.2
1-3 years 12.4
3-5 years 12.2
5 years + 45.2
Security profile %
Floating rate 51.8
Fixed rate 48.2
Other -0.1
Regional exposure %
Australia 69.7
USA 19.2
Europe ex UK 8.3
UK 2.7
Asia inc Japan ex EM 0.0
Emerging Markets 0.0
Fund details
Schroder Credit Securities Fund Holdings by composite broad credit rating %
APIR code SCH0103AU AAA 11.5
Fund size (AUD) AA 6.2
Redemption unit price $1.0994 A 19.1
Fund inception date BBB 30.6
Buy / sell spread 0.15%/0.15% BB 5.3
Management costs 0.75% B 2.1
Minimum initial investment $50,000 CCC and below 0.8
Distribution frequency Normally quarterly Cash 24.3
Not Rated 0.0
Unless otherwise stated figures are as at the end of January 2014
Figures may not total 100 due to rounding
Regional exposure is expressed by currency pre-hedging.
Contact
www.schroders.com.au
E-mail: [email protected]
Schroder Investment Management Australia Limited
ABN 22 000 443 274 Australian Financial Services Licence 226473
Level 20 Angel Place, 123 Pitt Street, Sydney NSW 2000
Phone: 1300 136 471 Fax: (02) 9231 1119
August-2002
Investment in the Schroder Credit Securities Fund (“the Fund“) may be made on an application form in the Product Disclosure Statement dated 1 February 2011, available from Schroder Investment
Management Australia Limited (ABN 22 000 443 274, AFSL 226473) (“Schroders”).
Schroder Credit Securities FundMonthly ReportJanuary 2014
$634,779,469
This Report is intended solely for the information of the person to whom it is provided by Schroders. It should not be relied on by any person for the purposes of making investment decisions. Total returns are calculated using exit price to exit price, after fees and expenses, and assuming reinvestment of income. Gross returns are calculated using exit price to exit price and are gross of fees and expenses. The repayment of capital and performance of the Fund is not guaranteed by Schroders or any company in the Schroders Group. Past performance is not a reliable indicator of future performance. Unless otherwise stated the source for all graphs and tables contained in this report is Schroders. Opinions constitute our judgment at the time of issue and are subject to change. This report does not contain and is not to be taken as containing any financial product advice or financial product recommendation. For security reasons telephone calls may be recorded.This Report is intended solely for the information of Wholesale Investors as defined under the Corporations Act. You agree not to pass on any credit rating and/or related research to a party who is not a Wholesale Investor.
Fund Objective To outperform the RBA Cash Rate after fees and deliver income through investment in credit and debt securities with a focus on preserving investor capital.
Key Features - Absolute return focus with an objective to outperform cash and minimise capital volatility. - Diversified pool of quality domestic and global credit and income securities. - Provide regular income; distribution policy closely aligning distribution payments with underlying income yield of the credit universe. - Well defined, disciplined and proven investment process that aims to ensure we are in the right assets at the right time. - Focus on risk adjusted returns where there needs to be appropriate reward for risk taken and the flexibility to be very defensive. - Strong domestic and global team, giving investors access to a broader opportunity set and the resources to analyse and monitor credit risk.
