Gopi Karunakaran

The ActiveX Ardea Real Outcome Bond Fund (Managed Fund), an actively managed fixed-income ETF from Ardea Investment Management, has been added to award-winning investment and superannuation platform, HUB24.

The ETF is the first release in Fidante’s ActiveX series and is available under the ASX ticker code, XARO. It is the first actively managed fixed-income ETF in the Australian market that is not constrained by an index.

XARO’s underlying fund, the Ardea Real Outcome Fund (ARO) has $591 million of AUM (as at 30 April 2019) and has a strong track record of delivering consistent low volatility returns since July 2012. Ardea manage $1.9bn overall in the Real Outcome strategy when institutional clients are included, and have over $11bn in FUM at a firm-wide level.

Over the past three years, as conventional fixed income investments have been challenged, ARO has outperformed with a return of 5.6% p.a.^[1] (net of fees), or 3.77% p.a. above the benchmark^[2]. Portfolio Manager, Gopi Karunakaran, said Ardea was looking forward to a long association with HUB24.

“We are delighted to have XARO available to HUB24’s clients. As one of the fastest growing platforms in the market, we expect the association to significantly boost adviser interest in XARO,” he said.

ARO invests in the same high-quality government bonds that are typical of conventional fixed income portfolios but generates returns from them in a way that is independent of whether bond yields are high or low, while also neutralising their inherent interest rate duration risk.

ARO does this by combining Ardea’s unique ‘relative value’ investment approach with efficient risk management strategies that are intended to succeed in adverse market environments. These are packaged into a defensive portfolio that prioritises liquidity and capital preservation, while delivering attractive returns.

Mr Karunakaran said these attributes were particularly compelling in the current market environment.

“The combination of ultra-low bond yields, rising interest rate volatility and late cycle credit risks have left conventional interest rate duration and credit-based fixed income investments facing more risk for less return” he said.

“ARO managed to deliver strong positive returns through the difficult market environment of 2018 when many fixed income investments, labelled as ‘defensive’, had performance challenged because of their exposure to volatility in credit markets and interest rates,” he said.

It has been a big week for the Ardea team, with XARO’s underlying fund, ARO, named as the top performing international fixed income fund for the three-year period to 31 March 2019 by investment research house, Rainmaker, returning 5.4% against a sector median of 3.4% (net of fees)3.

XARO is also available on BT Panorama, Asgard and BT Wrap platforms for both Investments and Super, and the Macquarie Wrap platform for Investments.

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Gopi Karunakaran

As the tailwind of synchronised central bank support for asset prices subsides, conventional fixed income strategies aiming for true risk diversification may struggle to achieve their objectives, says Ardea Investment Management portfolio manager, Gopi Karunakaran.

Conventional thinking has it that bond and equity prices have an inverse relationship: When a “risk off” scenario such as a recession occurs, capital flight to safety, together with the potential for interest rate cuts, causes bond prices to rise. In this way bond holdings can provide risk diversification against falling equity values.

However, Mr Karunakaran is urging investors to re-evaluate the widely held view that governments bonds are inherently defensive and risk diversifying in the current economic climate.

For the first time in years, the largest economies in the world are all growing and finally allowing central banks to look beyond monetary stimulus, despite still low inflation. If the consensus view of improving economic growth, contained inflation and gradual central bank policy normalisation does play out, bonds can provide stable income while exposing investors to risk of modest capital losses from rising interest rates (duration risk).

“Even in this scenario, the current combination of very low yields and term premia, means bond holders are being poorly compensated for bearing duration risk. The issue is compounded for passive bond investments as benchmark index duration is longer, therefore riskier, while average yields have declined and there is asymmetric risk of capital losses from rising interest rates,” he said.

“But if nascent inflationary pressures become more established, this would quickly shift focus to fear of inflation overshooting, forcing aggressive, unexpected and disruptive normalisation of monetary policy. Bonds would then become the catalyst for a broader sell-off in other asset classes, rather than acting as a defensive risk diversifier,” he added.

“We got a small taste of what such unanticipated policy tightening can do to markets during the ‘taper tantrum’ in 2013 when US Federal Reserve chair Ben Bernanke unexpectedly announced the possibility of reducing the Fed’s bond buying program. This caused bond prices to drop sharply and trigger a sell-off in equities. The negative correlation between bonds and equities has been less reliable in the years since.”

In fact, longer term data shows that bond-equity relationships are unstable, tending to be impacted by inflation and interest rate paradigm shifts. While such paradigm shifts are easier to identify in hindsight, there are enough early indicators suggesting we are in the initial stages of one.

Mr Karunakaran said that irrespective of whether this scenario plays out, the conclusion is the same –the assumed negative correlation between bonds and equities is not as reliable as hoped for.

“The implication for portfolio construction is clear. Re-evaluate the conventional assumption that owning government bonds is inherently defensive and risk diversifying. At best, it’s an expensive choice and at worst, it won’t work,” he said.

“There’s more to fixed income than just buying and holding bonds. It is an asset class with a wide range of instruments, strategies and return sources that can be exploited to achieve genuine risk diversification. For example, the same factors that distorted bond market valuations have also created relative value pricing anomalies, underpriced volatility, skewed risk premia and cheap tail risk opportunities.”

“Fixed income can still diversify portfolio risk, but only if you choose the right strategy,” he added.

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This appointment allows Ardea to increase capacity and further strengthen a team that has delivered consistent outperformance for investors. This strong performance is driving growth from the firm’s already well established institutional client business, in addition to burgeoning demand from retail advisors.

Ardea has a successful track record of actively managing a range of defensive fixed income strategies, including absolute return, benchmark aware and objective based solutions. The firm is an active investor across Australian and global government bonds, fixed income derivatives, inflation linked bonds and investment grade credit.

As Portfolio Manager, Gopi will focus on generating investment ideas and adds to the depth and diversity of experience in Ardea’s highly regarded investment team.

Gopi has more than 15 years’ experience in credit and relative value fixed income investing. Prior to joining Ardea, he spent four years in Singapore as a fixed income portfolio manager at Saka Capital. Before this he spent eight years as a portfolio manager and trader at Moore Capital, Tricadia Capital and Deutsche Bank in London.

Gopi began his career as a credit analyst at Deutsche Bank in Sydney. He holds a Master’s degree in Finance from the London School of Economics and Political Science and a Bachelor’s degree in Economics from the University of New South Wales.

Ardea also announced the appointment of Harry Singh, Dealing and Compliance. Harry previously worked as an investment compliance analyst at Challenger, where his responsibilities included monitoring mandate compliance, static data and pricing of Ardea’s fixed income portfolios.

Harry holds a Master’s degree in Accounting and Financial Management from La Trobe University and a Bachelor of Computer Science from Punjab Technical University.

Ardea Principal and co-founder Ben Alexander welcomed both additions who, he said, would allow Ardea to continue delivering superior client outcomes as the business grows.

“Ardea’s new appointments ensure that we are well resourced to extend our track record of actively managing defensive fixed income portfolios that exceed return targets, while prioritising liquidity and capital preservation,” he said.

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