From an initial universe of 121 strategies, 59 were assigned a rating, with five of these receiving Zenith’s highest designation ‘Highly Recommended’. A further 44 were assigned a ‘Recommended’ rating, while 10 achieved an ‘Approved’ rating.
 
Zenith’s coverage of the Fixed Interest asset class has continued to grow, with an additional 34 ratings. This extended coverage is representative of the continued demand by investors for a more diverse range of high quality products.

Zenith notes in particular a growing presence of specialist and less constrained fixed interest opportunities spanning income-focused, absolute return, and emerging market debt. 
 
Zenith’s View 
Senior investment analyst Andrew Yap stated that “In general, managers across Zenith’s recommended list performed strongly, showing a greater propensity to generate alpha while constraining downside volatility.”

Alpha was more commonly aided by active credit strategies that benefited from a continued narrowing in global spreads. In contrast to this, we noted a more neutral approach to duration management and at a time where inflationary pressures among developed economies remain subdued.
 
Yap added, “We have noted a greater willingness from sector participants to diversify their portfolios into lower grade spread securities in an effort to enhance income generating potential. We attribute this market thematic to the coordinated effort by central authorities to maintain cash rates at historically low levels to spur global growth.

“This has necessitated managers reallocating capital to other market segments where an increased yield premium can be secured. While Zenith believes this ‘thirst for yield’ can in part explain the increased demand for high-yield and emerging market debt, we are also wary these exposures can impact average credit quality, a factor that can lead to increased performance volatility. With credit spreads approaching pre-GFC levels, Zenith believes the pace of contraction may slow, necessitating managers to enact a more diverse set of macroeconomic trades to drive investment outcomes.”

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Mr Davis, who has held a number of different investment roles during his 13-year career with Vanguard, currently has responsibility for managing in excess of US$240 billion in bond index portfolios. He will relocate to Vanguard’s Australian head office in Melbourne where he will take over the regional CIO role from Mr Joe Brennan, who is returning to a senior role in the investment team at Vanguard’s Pennsylvania headquarters.

Mr Davis will lead Vanguard Australia’s experienced team of 45 investment professionals responsible for managing a wide range of equity and fixed income portfolios for both Australian and Asian investors.

The announcement is being made now to allow for a smooth transition and planned handover in line with Vanguard’s global management approach. It is expected the transition will be completed during the first half of 2013.

Vanguard’s incoming global Chief Investment Officer Tim Buckley said:

“Greg has considerable experience in managing more than 25 bond index fund portfolios and 14 ETFs. He will continue to ensure Vanguard’s offerings to investors are low cost, transparent, true to label, and uphold our tradition of portfolio management excellence.

“Joe has demonstrated great leadership through the extraordinary market volatility of the global financial crisis. We are extremely grateful for his many contributions to Vanguard’s Australian business and look forward to working with him on his return to our U.S. headquarters.”

The Managing Director of Vanguard Australia, Mr John James, thanked Joe for both his management of the investment team during a period of greater global integration and his contribution to the wider business as a member of the Australian executive team and a director of Vanguard Australia.

Mr Davis joined Vanguard in 1999 from Merrill Lynch. He is a member of the CFA Society of Philadelphia and serves on the board of trustees for Philadelphia Futures, a non-profit dedicated to serving economically disadvantaged students with programs and resources to succeed in college.

Mr Davis earned a B.S. in insurance from The Pennsylvania State University and an M.B.A. in finance from The Wharton School of the University of Pennsylvania.

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“Indeed, there is increasing evidence that many investors are confused by what fixed interest really means. 

“Equating fixed interest with term deposits is not a balanced approach and, from a diversification point of view, is not much better than having no fixed interest investments at all,” Mr Bovingdon said. 

He said that fixed interest securities play a crucial defensive role in any well-balanced investment portfolio. 

“Fixed interest can provide predictable, regular income and act as a foil against the losses made on equity holdings during an economic downturn. 

“However, a poorly constructed defensive allocation will fail in meeting defensive and risk-management objectives in times of market turmoil, such as we have seen in recent years. 

“Investors need to do some research to educate themselves about fixed interest investments. 

“Advisers should encourage their clients to spend the same sort of time understanding fixed interest as they do equity markets, to ensure they have a basic knowledge of the range of products that make up the fixed interest sector and the benefits and risks associated with each. 

“Not all assets that have been labelled fixed income are ‘true to label’, and furthermore, not all bonds are made equal. 

“Advisers and their clients need to be aware that some are inherently much more risky than others, and others are just not fit for purpose if the objective is to create a safe, predictable source of income that also diversifies a portfolio’s equity risk,” he said. 

Mr Bovingdon said investors and advisers should appreciate the two desirable characteristics of fixed income in a portfolio. 

He said they provide:

• a predictable and regular source of income (the investor gets predetermined coupons plus the principal back at maturity, making cash flows predictable)
• portfolio diversification.

“The importance of defensive role of bonds cannot be underestimated for all investors, and for some, such as retirees, it is particularly critical. 

“In addition, the relative stability of bond returns not only reduces overall portfolio volatility, but also over the medium to long term, bonds are negatively correlated to equity prices which improves the risk return profile of the overall portfolio. 

“These are points that investors should understand about fixed income,” he said. 

Altius has developed a list of risks that investors should consider for fixed interest investing, as well as a definition of investment products that make up fixed interest (see attached).

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The report covers a diverse number of products classified into Australian and global offerings and further by individual peer groups. These include “plain vanilla” bond funds that fall within the “fixed interest” classes and funds that differ in their make-up and therefore have a specific classification such as “credit” offerings including “high yield”. 

“For the past three years, our commentary on this asset class has incorporated discussions around the issues in peripheral European countries, and this year is no different. Performance in 2009 and 2010 was generally strong, but 2011 and the first half of 2012 proved to be a difficult time for active managers,” said S&P fund analyst David Erdonmez. 

Performance for our more core offerings has largely been dictated by duration and the ability to predict the future path of interest rates. Meanwhile, credit-focused offerings have been susceptible to widening spreads in a risk-off environment. 

Key points from the report are: 

• Bentham Asset Management and PIMCO are the only managers to receive our highest ratings in the global fixed interest sector with both managers retaining five-star ratings on their offerings.
• Tyndall Investment Management, PIMCO, Colonial First State Global Asset Management, and AMP Capital Investors received five-star ratings for their Australian fixed interest offerings.
• Two funds in our global fixed interest peer group currently remain ‘On Hold’. These are the OnePath Wholesale Diversified High Yield Trust, and the OnePath Wholesale Diversified Fixed Interest Trust.
• Turnover within investment teams was reasonable during this review cycle with the only notable change being team additions at UBS Asset Management. Former INGIM staff members Rachel O’Connor, and credit analyst Thomas Wu have permanently joined the team.

 9 July 2012

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PIMCO Australia was the winner of S&P’s Fixed Interest category in 2008, and Global Fixed Interest Category in 2009, 2010 and 2011. This is the first year PIMCO has been nominated for S&P Fund Manager of the Year.

Upon accepting the awards, Rob Mead, Head of Portfolio Management at PIMCO Australia, said: “PIMCO is thrilled to have won these three award categories and is pleased that our team and our approach has been recognised by Standard & Poor’s”.

Mr Mead said it was both a challenging and opportune time to be actively managing Australian and global fixed interest.

“PIMCO is a very active manager of Australian and global bonds and we aim to generate the best return within the context of minimising risk for investors,” Mr Mead said. “Having a global perspective and extensive global resources has generated a much deeper understanding of the forces driving Australian interest rates and credit spreads, and we’re delighted to see this approach has been recognised by Standard & Poors.”

John Wilson, Head of PIMCO Australia, said the award wins come as demand for fixed interest from retail investors surges. 

“Investors in the pre and post-retirement phase are increasingly drawn to fixed interest funds as an effective investment portfolio diversifier and a potential source of stable, reliable income for retirees,” Mr Wilson said

In their eighth year, the Standard & Poor’s Awards involve a qualitative assessment of specific investment management capabilities in a fund sector rather than being based on the past performance of individual funds. Finalists are selected from managers that have demonstrated superior quality in their investment capabilities and that S&P consider to be well positioned to sustain success.

PIMCO is a specialist fixed interest manager for clients worldwide. In Australia, PIMCO manages more than $30 billion across a wide range of fixed income funds and strategies for large superannuation funds, institutional investors, self-managed super funds and tens of thousands of individual investors.

Lee-anne Milton, Head of Research at S&P Fund Services, said that S&P had conducted in-depth analysis across a range of high-performing managers to decide the award recipients.

“The fund managers recognised this year are those we believe are more likely to outperform their peers and investment objectives through the full investment cycle,” she said.

To qualify for inclusion in the Awards, an investment capability must be available and open to Australian retail investors and it must be known and familiar to S&P.  The selection process considers investment management capability, peer relativity and achievement.  Investment capability is defined as a combination of investment strategy, investment team and investment process supported by appropriate risk management, compliance, administration and governance.

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So says Robert da Silva, Managing Director, Asia-Pacific Fixed Income, Principal Global Investors. “A number of themes have emerged in the massive shift that has occurred – and is continuing to occur – post-GFC, turning some of the accepted notions of fixed income investing on their head,” he said.

“It’s important for investors to stay in tune with these shifts and changes and think through their implications, both for their broader portfolios in the way assets are allocated and diversified within the fixed income space.” Some of the key changes Mr da Silva cited are: 

1.  A move away from government or sovereign debt.

“The old idea of government bonds being 100 per cent safe has been turned on its head in the wake of the peripheral European crisis and in the face of the looming debt ceiling deadline in the USA, and its potential to lead to a downgrade. While a Congressional vote to lift the ceiling is likely, the situation has thrown into question the accepted ‘guaranteed risk-free’ status of US Treasuries,” said Mr da Silva.

This situation is linked to one of the key post-GFC themes: the massive shifting of debt from the private sector into government, which leads to the next change.

2. Increased appeal of corporate, or private, debt.

While government has been taking on a greater debt burden, corporates have spent the years since the GFC intensively deleveraging and divesting themselves of non-performing businesses and assets.

“High yield default rates are continuing to fall and the corporate sector is in many respects sounder and more prudent than its public counterpart,” Mr da Silva explained.

Mr da Silva pointed out that this is particularly evident in the credit default swap market, where the cost of insuring government debt has soared – from two basis points for $5 million in US Treasuries pre-GFC to some 53 basis points today.

“We now find ourselves in the unprecedented situation where there are 29 companies with lower credit default swap spreads than for the US Sovereign: IBM, McDonalds, Walt Disney, Wal-Mart and UPS, just to name a few.” 

3. Equities: no longer the only growth asset?

“When you look at the past 10 years in the United States, the S&P 500 has barely moved,” said Mr da Silva.

“We are looking at 1372.71 at end-June 1999 to 1320.64 at end-June 2011, a return of -0.32% each year for 12 years. These are ex-dividend figures, but even including dividends only brings the return to +1.50%, well behind 3 month T-Bills (+2.58%) and consumer inflation (+2.54% p.a.). I think this should call into question some of the generally held underlying assumptions about long term growth assets.

So, what does all this mean for the fixed income investor?

“An intelligent approach is to insulate the portfolio from the downside and focus on the opportunities,” said Mr da Silva.  

“We suggest closer involvement in the credit market, looking at corporate, high yield and emerging market assets in particular, with an eye out for the right asset-backed and credit-backed securities. This is particularly the case in the light of what’s happening with commercial property in the United States, which is coming back, with commercial-mortgage-backed securities still priced relatively cheaply despite yields coming down a bit recently.”

The second feature to look out for is duration – specifically, shorter term.

“We are looking at shorter durations in order to hedge against concerns about inflation and rate rises on the horizon, so we can minimize the damage should that occur.

“Again this is a departure from conventions where investors generally would look at longer bond funds, and again this is what we believe is required to succeed in the new environment. It’s all about staying alert and informed, and acting strategically.”

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Fixed interest manager PIMCO/Equity Trustees has won leading investment researcher Morningstar’s Fund Manager of the Year Award for fixed interest, for the second successive year.

Morningstar determines winners of its Fund Manager of the Year Awards through a combination of qualitative research by Morningstar fund research analysts; together with the manager’s risk-adjusted medium-to-long-term track record and performance in the calendar year. The fixed interest award includes both international and domestic fixed interest.

“There’s not much that hasn’t already been said about PIMCO, but the shop’s expertise in building fixed interest portfolios continues to reward Australian investors,” Morningstar said of PIMCO’s 2010 win.

“PIMCO founder Bill Gross is the face of this operation, but he’s surrounded by a deep and talented pool of professionals who demonstrate superior judgement when evaluating macroeconomic conditions and the optimal securities to own. PIMCO continues to perform with aplomb, and few fund managers can match the firm’s credentials and intellectual firepower,” Morningstar said.

Robert Mead, Head of Portfolio Management at PIMCO Australia, said he was pleased that PIMCO had won the coveted award two years running and said this reflected the quality and focus of the team.

“Winning the Morningstar award two years in succession reflects the global reach and outlook of PIMCO’s international and domestic fixed interest team and the talent and hard work of our portfolio managers,” Mr Mead said.

Peter Dorrian, PIMCO Head of Global Wealth Management Australia, said that financial advisers and investors should continue to feel confident about PIMCO’s management of the fixed interest component of their portfolio.

“PIMCO is an active manager of international and Australian fixed interest and looks to identify the best opportunities for investors against the backdrop of constantly changing market conditions. Fixed interest provides both diversification and income to yield conscious investors’ portfolios, while seeking to smooth volatility,” he said.

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PIMCO’s actively managed bond funds continue to outperform both local and global equities though market conditions are set to become challenging for fixed interest as the world economy recovery post GFC gathers pace.

As the market anticipates growth in the US in particular, PIMCO believes short-term rates are set to rise in the global developed world in 2012 with spikes already evident in long-term rates. However, PIMCO believes the changing climate provides scope for active managers to demonstrate their value and act as both an income generator and stabiliser for portfolios.

Peter Dorrian, Head of Global Wealth Management at PIMCO, said actively managed bonds will continue to produce steady returns to income conscious investors in a challenging environment.

“The need for bonds remains essential as the risk rally is likely to run out of steam mid-year,” he said.

“We believe fixed interest has a place in every portfolio, regardless of the economic environment. All investors should retain exposure to the asset class as a diversifier and as an important means of lowering overall portfolio volatility,” Mr Dorrian said.

The PIMCO Australian Bond Fund has continued to perform strongly, outperforming the Australian share market by almost eight per cent as measured by the ASX 200 over calendar 2010. The fund also outperformed over three and five year periods.

The outperformance of PIMCO’s bond funds has also included global markets. The EQT PIMCO Global Bond Fund outperformed the Australian share market over one, two, three and five year periods including a 15.67% return in calendar 2010.

“Over a five-year period, PIMCO’s Australian and global bond funds have comprehensively outperformed the ASX 200. The results show bonds can outperform equities with less volatility,” Mr Dorrian said.

While past returns are no guarantee of future returns, funds such as the Australian Bond Fund and Diversified Fixed Income Fund should continue to provide value for investors.

“In difficult investment environments, active management of fixed interest can help ensure clients’ funds are more effectively administered through superior macroeconomic forecasting, adjusting portfolio duration and strong credit analysis capabilities,” he said.

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Fixed interest manager PIMCO Australia’s EQT Diversified Fixed Income Fund has been awarded a ‘Highly Recommended’ rating by Lonsec, in its first rating of this fund.

The actively managed DFI fund provides a broadly diversified exposure to domestic and international fixed interest markets by investing 50% in the PIMCO Australian Bond Fund and 50% in the PIMCO Global Bond Fund. The fund will at times also have a modest allocation to high yield and emerging markets debt.

“This rating primarily reflects Lonsec’s regard for the depth and quality of PIMCO’s investment team which is focused on top down and bottom-up analysis. Lonsec believes PIMCO benefits from a well established top down and bottom up portfolio construction process with highly formalised and disciplined decision making covering duration, yield curve and sector positioning, driven by its Global Investment Committee,” said Andrew Coutts, Lonsec senior investment analyst.

The global portfolio is managed in the US by PIMCO founder Bill Gross, with the domestic portfolio managed by Rob Mead.

“Lonsec regards Rob Mead as a quality investment professional with significant experience in the industry and with PIMCO,” Mr Coutts said.

The Lonsec review “notes that the Fund has exhibited the strongest track record in the Lonsec Peer Group of outperformance across both ‘down’ (63%) and ‘up’ (68%) markets over the three years to November 2010, with ‘all’ markets outperformance for the Fund also being 67% compared to the Lonsec Peer Group’s average of 49%.”

Lonsec notes the Fund’s ‘total return’ approach implies a degree of indifference as to the source of returns either from income/distributions (e.g. coupons) or growth (e.g. asset price growth).

“This may result in significant active positions away from the benchmark in an attempt to add value for investors,” said Mr Coutts. The Manager believes that focusing on the on longer term (3-5 year) secular trends presents better opportunities for the Manager to outperform relative to the broader market.

“Lonsec is pleased with PIMCO’s renewed emphasis on risk management, including the development of advanced risk management and portfolio monitoring systems,” Mr Coutts said.

The fund is managed to maximise total returns, with a target tracking error of 2-3% relative to a composite benchmark, which comprises the Barclays Capital Global Aggregate Bond Index hedged to Australian dollars and the UBS Australian Composite Bond Index.

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Zenith Investment Partners Pty Ltd (Zenith) Investment Analyst Steven Tang has announced the completion of the 2010 Fixed Income Sector Review and confirmed that from an initial group of 91 fixed interest funds, 7 were rated HIGHLY RECOMMENDED and 12 were rated RECOMMENDED.

In addition to being added to the Zenith Recommended List these 19 Funds are also candidates for client model portfolios.

The key changes to the Recommended List post the review include the addition of 5 new funds across various categories as well as upgrades for 2 existing funds. The 19 funds that were rated Recommended or above are shown below:

Australian Fixed Interest – Bonds

• Australian Unity Vianova Strategic Fixed Interest Trust (Recommended)
• Legg Mason Australian Bond Trust *NEW* (Recommended)
• Tyndall Australian Bond Fund (Highly Recommended)
• Vanguard Australian Fixed Interest Index Fund (Recommended)

Australian Fixed Interest – Corporate Debt

• Macquarie Income Opportunities Fund (Highly Recommended)

Australian Fixed Interest – Specialist

• Goldman Sachs JBWere Core Plus Australian Fixed Interest Fund (Highly Recommended)
• Perennial Tactical Income Fund (Recommended) International Fixed Interest – Bonds
• Advance International Fixed Income Multi-Blend Fund *UPGRADE* (Highly Recommended)
• EQT PIMCO Wholesale Global Bond Fund (Recommended)
• Vanguard International Fixed Interest Index Fund *NEW* (Recommended)

International Fixed Interest – Corporate Debt

• Colonial First State Wholesale Global Credit Income Fund (Highly Recommended)
• Bentham Global Income Fund (Recommended)
• Bentham Syndicated Loan Fund *NEW* (Recommended)

Diversified Fixed Interest

• Colonial First State Wholesale Diversified Fixed Interest (Recommended)
• EQT PIMCO Wholesale Diversified Fixed Interest Fund *NEW* (Recommended)
• Macquarie Diversified Fixed Interest Fund (Highly Recommended)
• MLC Diversified Debt Fund *NEW* (Recommended)
• Schroder Fixed Income Fund *UPGRADE* (Highly Recommended)
• Vanguard Index Diversified Bond Fund (Recommended)

Last year’s Fixed Interest Sector Report focused on the changing nature of Bond Indices and the effects this could have on future performance of fixed interest portfolios as well as the importance of maintaining Strategic Asset Allocation.

While these topics remain relevant today, this year Zenith chose to address some investor concerns, specifically whether to use diversified fixed interest funds or specialist sector funds and the veracity of the ‘Bond Bubble’ claims.”

The last few years have been a roller coaster ride for investment markets and investors alike. During this period many investors were understandably disappointed with the performance of their investments, particularly those they thought were defensive.

Unfortunately, many products labelled as diversified fixed income funds were among these defensive investments that failed to deliver on expectations.

Following this disappointing period it’s not surprising that many investors questioned their fixed income allocations. The natural question became ‘if the diversified offerings had failed to deliver on expectations would it be better to segregate the fixed income allocation and allocate to specialist managers?’

In response, Steven Tang offered the following insight, “While a simple portfolio construction exercise, in which mandates are separated and return data over the past few years is used, lends credence to the intuitive appeal of this idea (based on the presumption that these specialised managers have superior skills within their more defined mandates), the outcome is highly dependent on the investor making the correct initial and ongoing asset allocation decision.”

Although it’s simple in hindsight it’s historically a very difficult task to execute successfully and can dramatically change the outcome. Performance over the past few years by diversified fixed income managers has been more a reflection of their strategic benchmarks than their lack of skill in this area.

Given the changing fixed income landscape these managers remain better placed to exploit the diverse range of opportunity sets, alleviating investors of the complex asset allocation decision.

It’s for this reason that Zenith’s Recommended List and fixed interest portfolio exposures remain biased to Diversified Fixed Interest Funds.”

In reference to the debate concerning the existence and threat of a ‘Bond Bubble’ in the US Treasury market Steven Tang observed that using the typical definition of a ‘Bubble’, i.e. irrational market behaviour driven by speculative mania, it’s unlikely that the US Treasury market represents a ‘Bubble’.

Unlike other financial markets, investors know exactly what returns they will receive if they hold until maturity (assuming no defaults). Additionally, short-term gains are likely to be very modest given current yields. More likely investors are looking for a safe haven for their savings given their torrid experiences of the last few years and the current uncertainty in global financial markets.

Steven Tang concluded, “Nevertheless, it’s definitely possible that investors could face a capital loss as bond yields rise. However, while they may not remain at their current lows, it’s difficult to see a near term catalyst for a rapid rise in yields which would result in large investor losses.”

“In the future, US growth may surprise on the upside, the US Federal Reserve may maintain its loose monetary policy for far too long, creating massive inflationary pressures, or demand for US Treasuries could dissipate making US Treasuries an appalling long-term investment.

“But not in the near-term.”

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