A closer look…..

As we have highlighted on many previous occasions, the extraordinarily low interest rates around the world are forcing investors to take on more risk just to sustain (rather than grow) their income each year. Now, this is all well and good if these investors have undertaken due diligence and understand what it is they are investing in. Unfortunately, this isn’t always the case. With this mind, we wanted to take a closer look at the very popular Neuberger Berman Global Corporate Income Trust. We have broken our analysis down into a few simple sections:

Who is Neuberger?

Neuberger is a New York based fund manager with expertise across most sectors of the market including equities, fixed income and alternatives. They were established in 1939 and have over $455bn under management globally with closer to $7bn under management in Australia, primarily with institutions. It’s important that investors do not confuse size with security, as whilst the manager itself is extremely successful and huge by Australian standards, they do not control the performance of the underlying investments.

What is the fund?

The Corporate Income Fund is a specialist income focused fund that invests solely into senior bonds issued by global listed companies. This includes secured and unsecured senior debt which are both positioned at the top of the capital structure and first in line in the event that an issuer defaults on their obligations or moved into bankruptcy.

What does it invest in?

The Corporate Income Fund invests into what is commonly referred to as ‘junk bonds’, ‘high yield’ bonds or unrated credit. At present, the portfolio holds less than 1% in what are considered investment grade bonds, with a rating above BBB with the remainder allocated as follows:

The fund is managed according to a number of overriding allocation restrictions with the primary one being an asset allocation of 60% to the US, 20% to Europe and 20% to emerging markets. Management aim to hold between 250 to 350 individual bonds with an external rating by one of the majors of BB or B. The geographic and sector allocations are as follows:

What are the risks?

In our view, the risks of this investment are substantially higher than many of both its investors and the financial planners who recommended it truly understand. The fund invests bonds issued by institutions that fall many rungs below the likes of the Commonwealth Bank on the credit ratings scale. For instance, the largest current holding is Petrobras bond, lending money to the Government-backed Brazilian gas and oil producer.

More importantly investors are exposed to an immensely higher risk of default on the loans made through this fund than through the likes of a Bond Fund issued by PIMCO or Schroder’s. Yet the managers are extremely clear with this fact in all their publications reporting that essentially none of the underlying investments would pass the investment grade requirement. This represents a substantial risk to investors for many reasons, but primarily, the risk of default is substantially higher. The table below shows the probability of default for various bonds rated by market-leader Standard and Poor’s (S&P) over many decades. As you can see, the CCC rated bonds, which makeup 11% of fund today, have a 26% probability of defaulting in the first year of their issue, which increased to 50% (yes 50%) after just 8 more years. This is substantially higher than the .08% probability of one of Australia’s banks going bankrupt.

The managers rely on a substantial amount of diversification to reduce the impact of any one issuer defaulting, however, in many cases this sector of the bond markets is already highly leveraged. For instance, the largest exposures are to cyclical or struggling sectors including energy and media all of which are being disrupted on a daily basis.

Our View

Be careful what you wish for. To be honest, we don’t believe an investment of this risk level is suited to the majority of superannuants, pensions and mum and dad investors that make up its share register. The fund was opportunistically listed at a time when Australian investors were seeking alternatives to fully franked dividends under the threat of a Labor Government; to this we say well done. The managers were able to leverage off this concern to raise close to $1bn in ‘forever capital’. If you were not aware, the benefit of an LIC or LIT (listed investment trust) for managers is that the capital raised will remain forever, there are no redemptions or purchases, the units are simply traded on the stock exchange. So Neuberger have effectively locked in 0.85% of management fees on $1bn in perpetuity.

PIMCO Global Bond Fund

What’s the fund?

This month we are taking a closer look at the PIMCO Global Bond Fund. The fund is a traditional, long-only bond fund meaning the managers buy and hold the individual investments. There are no short positions and the funds positions are actively managed. The underlying investments are generally limited to investment grade bonds issued by Government, Semi-Government institutions, corporates and mortgage securities.

PIMCO is renowned as one of the world’s premier fixed income managers. PIMCO or Pacific Investment Management Company was founded in 1971 in Newport Beach, California and has grown to invest $1.84 trillion on behalf of individuals and institutions across the world. PIMCO employs over 2,700 investment professionals across 17 offices spanning the globe.

PIMCO are widely known for creating the ‘absolute return’ approach to fixed income investing, as opposed to simply letting markets be markets. The firm’s investment approach is very much driven by Macroeconomic views. These are constructed, collated and challenged through an intensive investment committee and review process. It involves regular Cyclical Forums, which seek to anticipate 6 to 12 month market trends, as well as the annual Secular Forum which projects trends over the coming 3 to 5 years. The firm then relies on individual experts to provide bottom up perspectives on individual securities, companies and sectors.

The fund is managed by the highly experienced Andrew Balls, who is the Chief Investment Officer for Global Fixed Income. He is based out of London, has been with PIMCO for 13 years and previously worked as a correspondent for The Financial Times newspaper.

The Australian fund has been running since April 2004 and has over $6.4bn in assets under management. The fund is benchmarked against the Bloomberg Barclay’s Global Aggregate Bond index. In addition to the core Global Bond Fund, PIMCO have recently launched an ESG or Environmental Social Governance overlay which seeks to ensure its investments have a positive impact on the world.

Where does it fit in your portfolio?

The Global Bond fund is a diverse, actively managed portfolio of global fixed income securities. The fund’s benchmark is the Bloomberg Barclay’s Global Aggregate Index which seeks to measure the returns of a diversified pool of bond issues by companies around the globe. The fund meets the requirements of the Capital Stable Bucket, being to generate a return of CPI+3% per year and ensure that your investment will retain its value in difficult market conditions, as it invests primarily in investment grade bonds and actively manages the risk in the portfolio. The underlying assets include bonds and similar fixed income securities issued by developed and emerging market Government’s, Semi-Government institutions, Corporates and high yield issuers. Management have experience investing over four decades and various major events from the Global Financial Crisis, to the Asian Crisis and various global conflicts.

Why invest?

With term deposit rates now falling well below 2%, but the risks to sharemarkets seemingly growing by the day, what you do with your Capital Stable allocation will have a larger effect on your returns.

The PIMCO Fund offers a core global bond exposure, diversified across emerging and development markets, corporates and governments. The nature of the underlying fixed income investments mean the fund will provide a hedge against equity market volatility and benefit from increasing demand for lower risk assets or a further compression in bond yields.

In recent months, experts suggest that this may be a time to be reducing exposure to bond markets. Yet, this oversimplifies the operation of bond markets and the all-important yield curve. The benefit of PIMCO’s strategy is that it is benchmark unaware and they are able to take active positions based on their long-term expectations for individual economies, markets and companies. This affords the managers flexibility to reduce the duration of their portfolio, currently around 7 years, and target specific periods on the yield curve where they believe opportunities are presenting. Duration is a measure of a bond’s sensitivity to movements in interest rates, as opposed to term to maturity which is the average term of each bond within the portfolio. Both are measured in terms of years, with a higher duration meaning any changes in interest rates will have a greater effect on the value of the portfolio.

PIMCO’s flexible mandate means they can be exposed to the potential for rate increases or decreases in various periods in the future. One such opportunity, is the threat of a slowing US or global economy in the next 3 to 5 years, which is likely to trigger a strong period for bonds. The fund currently holds its largest overweight position in bonds of this maturity, meaning investors stand to benefit if their assessment is correct. The fund also applies a number of ESG screens across the portfolio excluding companies involved in weaponry, pornography and tobacco and embracing those committed to improving environmental and social practices.

What does it invest in?

The PIMCO fund is wary of its benchmark index, but is not required to replicate it. The managers charge a management fee of 0.69%, and are paid to make major investment and allocation decisions on your behalf. The benchmark holds over 24,000 individual holdings by 4,500 issuers based all over the world. The managers seek to identify the best risk-reward opportunities from this universe whilst maintaining a core fixed income exposure through Government bond holdings. Some of the important details on the underlying portfolio include:

  • Credit ratings: 91% of all investments are held in investment grade debt rated above BBB. The average rating is A+.
  • Duration: The portfolio is predominantly weighted to Developed Government Debt, where 3.9 years of the 7.4 total duration are sourced and with a focus on the US, 3.3 years duration. More broadly the portfolio is allocated as follows:
  • Yield curve: The yield curve explains the relationship between the term to maturity and return offered for various bonds, with the general expectation that the longer the term, the larger the yield or return. The fund is currently diversified as shown below. As you can see, the largest weightings are to longer term bonds, specifically those with 5 to 7 and 10 plus years to maturity.

The most important and comparable details for the underlying portfolio are as follows:

  1. Fund duration – 7.41 years – reflecting a high level of exposure to interest rate movements and the expectation that further rate cuts or increases will have a substantial impact on the value of the portfolio. This is broadly in line with the benchmark duration of 7.19 years.
  2. Yield to Maturity – 1.88% – reflecting the income that would be received by investors if the underlying bond portfolio was held to maturity. Whilst low in historical terms, this compares favorably to the many negatively yielding Government bonds around the world.
  3. Average coupon – 2.64% – reflecting the interest paid by the underlying bonds.
  4. Average maturity – 11.04 years – reflecting the average maturity of all bonds within the portfolio based on their size.

How has it performed?

The fund has performed incredibly well in the short-term, benefitting from continued moves by global central banks to 0% rates around the world. The 12 months to 31 August saw the fund deliver a return of 8.6%, albeit a little below the 10.0% delivered by the benchmark over the same period. The funds underperformance was due primarily to their focus on higher quality, investment grade bonds rather than the broader investments that form part of the benchmark.

Longer term returns have also been strong, 4.29% compared to 3.87% over the last three years and 7.79% per annum over the last 10 years. Obviously, the returns in the future will be determined by movements in interest rates and bond markets but with a worsening global outlook, inflated valuations in equity markets the fund is well positioned to benefit from a period of volatility. Most importantly, it shows little correlation to equity markets.

What income does it provide?

As with all managed funds, the PIMCO Fund must distribute all income and realised capital gains each year. Therefore, distributions are dependent on both the performance of the underlying investments and whether any investments are actually sold or mature. As an actively managed strategy, the fund regularly turns over their underlying holdings and also receives distributions from most investments on a quarterly basis. The result is a long history of quarterly returns with averages as follows:

  • 3% for 12 months;
  • 9% for 3 years;
  • 1% for 5 years;
  • 4% for 10 years.

Neuberger Berman Global Corporate Income Trust

We have highlighted on many previous occasions, the extraordinarily low interest rates around the world are forcing investors to take on more risk just to sustain (rather than grow) their income each year. Now, this is all well and good if these investors have undertaken due  diligence  and understand what it is they are investing in. Unfortunately, this isn’t always the case.

As independent financial advisers, we are regularly approached by any number of fund managers seeking to distribute their latest  product  to as many people as possible. Listed investment companies have been increasing popular in recent months, with the sector doubling since 2014 due primarily to the fat commissions they offer financial advisers for recommending their products. The obvious  risk  in  this instance is that it is not unlike what occurred with the likes of Timbercorp and Great Southern, that many revenue driven advisers shirk the need for due diligence and focus simply on the commission they will receive. Interestingly, with the move to discretionary managed accounts, the investor may not even know they hold the product until well after the fact.

Of course, we aren’t saying that all listed investment companies are justified solely by their commissions, but that it’s important to understand what it is your investing in.

With this mind, we wanted  to  take a closer look at the very popular Neuberger  Berman Global Corporate Income Trust. Incredibly, despite the fund manager and strategy having no previous exposure to the Australian sharemarket, they were able to raise close to $1bn from investors. The fund was distributed by an extensive list of brokers, joint leader managers and ‘co-managers’ including Evans Dixon, Morgan’s, National Australia Bank, Ord Minnett, Bell Potter, Paterson’s, Shaw and Partners and Wilson’s. The fund was also marketed heavily by Peter Switzer’s media business and conference program.

We have broken our analysis down into a few simple sections:

Who is Neuberger?

Neuberger is a New York based fund manager with expertise  across most sectors of the market including equities, fixed income and alternatives. They were established in 1939 and have over $455bn under management globally with closer to $7bn under management in Australia, primarily with institutions. It’s important that investors do not confuse size with security, as whilst the manager itself is extremely successful and  huge by Australian standards, they do not control the performance of the underlying investments.

What is the fund?

The Corporate  Income  Fund  is  a specialist income focused fund that invests solely into senior bonds issued by global listed companies. This includes secured and unsecured senior debt which are both positioned at the top of the capital structure and first in line in the event that an issuer defaults on their obligations or moved into bankruptcy. The fund targets an annual income of 5.25% delivered monthly through regularly distributions and to complement this through active management and  investment  selection  with   an absolute positive return the secondary aim. The fund is run by one of the largest non-investment grade fixed income teams in the world, with over 50 dedicated staff.

What does it invest in?

The fund is managed according to a number of overriding allocation restrictions with the primary one being an asset allocation of 60% to the US, 20% to Europe and 20% to emerging markets. Management aim to hold between 250 to 350 individual bonds with an external rating by one of the majors of BB or B. The underlying portfolio is heavily diversified, which in some instances would be considered as   a way to reduce the risk of yourThe Corporate Income Fund invests into what is commonly referred to as ‘junk bonds’, ‘high yield’ bonds or unrated credit. At present, the portfolio holds less than 1% in what are considered investment grade bonds, with a rating above BBB with the remainder allocated as follows:

The fund is managed according to a number of overriding allocation restrictions with the primary one being an asset allocation of 60% to the US, 20% to Europe and 20% to emerging markets. Management aim to hold between 250 to 350 individual bonds with an external rating by one of the majors of BB or B. The underlying portfolio is heavily diversified, which in some instances would be considered as   a way to reduce the risk of your investment. The geographic and sector allocations are as follows:

Thus far, the fund has delivered on its objectives, delivering a  return of 6.63% since inception including an income of 4.74%. The fund  has, however, only been operating since   September   2018, which is an extremely short period of performance to review.

What are the risks?

In our view, the risks of this investment are substantially higher than many of both its investors and the financial planners who recommended it truly understand. The fund invests into fixed rate, senior bonds, issued by institutions that fall many rungs below the likes of the Commonwealth Bank on the credit ratings scale. For instance, the largest current holding is Petrobras bond, lending money to the Government-backed Brazilian gas and oil producer. Being fixed rate securities, the entire portfolio is subject to the risk that prevailing interest rates, primarily in the US, begin to rise once again, whether due to inflation or a stronger economy, resulting in a reducing value of these bonds and potentially a capital loss on the investment.

More importantly, however, investors are exposed to an immensely higher risk of default on the loans made through this fund than through  the likes of a Bond  Fund  issued  by PIMCO or Schroder’s. Yet the managers are extremely clear with this fact in all their publications reporting that essentially none of the underlying investments would pass the investment grade requirement. This represents a substantial  risk  to investors for many reasons, but primarily, the risk of default is substantially higher. The bottom right table shows the probability of default for various bonds rated by market-leader Standard and Poor’s (S&P) over many decades. As you can see, the CCC rated bonds, with makeup  11% of fund today,  have  a 26% probability of defaulting in the first year of their issue, which increased to 50% (yes 50%) after just 8 more years. The trend improves as you move into B rated  bonds that make up 45% of the portfolio, but at 13% after three years, this is substantially higher than the .08% probability of one of Australia’s banks going bankrupt.

Of course, this is all well and good if the investor is aware of the risk and secondly, comfortable with the level of volatility that may be ahead. The managers rely on a substantial amount of diversification to reduce the impact of any one issuer defaulting, however, in many cases this sector of  the  bond  markets  is already highly leveraged. For instance, the largest exposures are to cyclical or struggling sectors including energy, basic industry and media all of which are being disrupted on a daily basis and potentially entering a structural decline. The threat of higher interest rates isn’t limited to the value of the fixed rate bonds, but the viability of the companies issuing them in an increasing competitive environment.

Our View

Be careful what you wish for. To  be honest, we don’t believe an investment of this risk level is suited to the majority of superannuants, pensions and mum and dad investors that make up its share register. The fund was opportunistically listed at a time when Australian investors were seeking alternatives to fully franked dividends under the threat of a Labor Government; to this we say well done. The managers were able to leverage off  this  concern to raise close to $1bn in ‘forever capital’. If you were not aware, the benefit of an LIC or LIT (listed investment trust) for managers is that the capital raised will remain forever, there are no redemptions or purchases, the units are simply traded on the stock exchange. So Neuberger have effectively locked in 0.85% of management fees on $1bn in perpetuity.

We believe this type of strategy may be appropriate for large institutions seeking to complement high quality Government bonds or cash balances with a small allocation to unrated bonds and who have sufficient capital to offset any losses as they occur. We do not, however, believe the strategy is particularly suited to the conditions in which the global economy currently finds itself. An investment in junk bonds is generally best made when interest rates are high and falling, as this provides both earnings and valuation tailwinds. With the launch of this fund in Australia coming towards the obvious end of a 10 year bull market and with US rates increasing, the timing in our view is questionable. The largest issuers in this sector have and will remain companies under pressure, as few others are willing to lend to them. Whilst these may be large companies by Australian terms, the pitch presentation relied upon a comparison of the ‘median’ revenue of these companies being $7.67bn versus the ASX 200  of just $1.41bn, this comparison is irrelevant given Australia represents just 2% of global sharemarkets and it’s the quality of the underlying businesses that matter most.

One of the less considered risks of this LIT is that many of the underlying bonds that form this portfolio, whether in smaller US companies, or emerging markets, are substantially less liquid than traditional bond markets and in many cases are traded over the counter rather than on a listed exchange. We have always been wary of investment strategies offering investors exposure to less liquid investments via highly liquid structures like listed shares.

In conclusion, we believe this strategy has no merit and the 5.25% promised monthly income is not sufficient to offset the substantially higher risks of default.

The Wattle Watch

In any given month, Wattle Partners meets with many different professionals offering a new investment product, idea or scheme. Most are a pass from us, but now and again some pique our interest. 

It was a busy few weeks for the Investment Committee with a number of interesting managers presenting in the Wattle Partners office. We will cover these in future issues but one particular highlight came from Sanaka Capital.

Sanaka Capital is a specialist Indian private equity player run by Shankar Narayanan, who spent many years at global private equity giant Carlyle. He has extensive experience on the ground in India and has acted as CEO of many investee companies over several decades.

The fund is seeking to raise USD$500m for a 10 year investment period with most companies falling in the small and mid-cap size range. They plan to invest a minimum of $10m in each company and are targeting the highest growth but somewhat defensive themes including consumer staples, financial services, healthcare, manufacturing and chemicals.

The strategy will focus on investing into companies with a track record of profitability, rather than loss makers, and which are servicing niche sectors of the economy where 75-100% of the fund will be invested. They will be encouraged to use the capital and expertise of the manager to expand into under serviced areas of India that offer both community and investment benefits.

India remains one of the highest growth economies in the world, expected to grow at 7.8% in 2019, after increasing 7.4% in 2018 and is quickly undergoing a huge transformation under a re-elected Modi Government. India is the youngest large economy in the world, the number two population online internet users at 462m and the number two producer of fruit’s and vegetables.

Management noted the major reasons behind each sector as follows:

  • Consumer – favourable demographics, rising income levels, growing awareness, improving access and a shift to branded goods.
  • Healthcare – increasing life expectancy, rise in chronic diseases, increasing insurance penetration and medical tourism.
  • Financial services – economic growth, high savings rate and increasing need for credit and savings account;
  • Technology – skilled english speaking workforce, highly qualified talent pool with signficant scale potential;
  • Manufacturing – huge semi-skilled labour force, Made in India initiative, and a quality engineering and technical talent pool.

The fund typically targets investment opportunities that have the ability to deliver annualised returns exceeding 30% per year over the 3 to 5 year investment periods. The managers charge a standard private equity fee of 2% for annual managemet and 20% of outperformance over 8%. This fund typically requires a minimum investment of $1m but is accessible exclusively through Wattle Partners at substantially lower levels.

Antipodes Global Fund

What’s the fund?

This month we are taking a closer look at the Antipodes Global Fund. The fund is an unconstrained, long-short global share fund that seeks to generate positive returns above it’s benchmark in all market conditions. The management team define themselves as being pragmatic value in that they seek both traditional deep value companies as well as growth companies being mis-priced by the market.

Antipodes was founded in 1 July 2015 by the Portfolio Manager and CIO, Jacob Mitchell. Jacob was previously the deputy to Kerr Neilson at Platinum Asset Management, where he spent 14 of his 22 years of experience. Jacob is supported by Graham Hay (23 years’ experience) and Andrew Baud (15 years). Staff own 76% of Antipodes with the remainder held by Pinnacle Investments, their administration and marketing partner.

They implement a fundamental value focus to analyzing companies and operate in a niche within global markets; being the identification of underappreciated companies in the midst of structural change. Their view is that markets have a tendency for ‘irrational extrapolation’, or pricing in the current circumstances in perpetuity, which presents opportunities on both the long and short side through patient, fundamental research.

Where does it fit in your portfolio?

The Antipodes Fund fits the requirements of the Thematic Bucket as its underlying investment philosophy is to identify investments based on broad ‘cluster’ or global ‘themes’. These can be societal, sectoral or country specific, but all are focused on purchasing an undervalued company that will benefit from substantial earnings growth.

At present, they believe that US domestic companies and global developed market defensives (like infrastructure and utilities) are expensive compared to their trend and therefore ripe for a correction. They believe that European, Japanese and Korean domestic sectors are comparatively more attractive and offer a greater margin of safety. Further, they have an increasing exposure to Chinese technology and related businesses that have been sold off due to the trade war as well as industrial conglomerates throughout the world undergoing much needed transformation.

Why invest?

During Jacob’s previous tenure, he was able to achieve excess returns of 5.7% per annum over the benchmark in the Platinum Unhedged Fund and 9.9% in the Platinum Japan Fund, over the last 7 years. It is this time spent focusing on the Japanese and Asian markets that we believe warrants investing into Antipodes over the alternatives, as we believe Asia will be the growth driver for the global economy in the years ahead but is generally underrepresented in managed fund portfolios. The fund has grown from inception to around $6.5bn under management in 2019 reflecting the strength of their investment process.

We prefer the Antipodes Fund because we believe the opportunities available offshore are more attractive than those in Australia and the value-oriented approach implemented by the managers will complement well with the growth focus of the other international managers. The Antipodes team have a great deal of experience investing throughout Asia, including China, India, Hong Kong, Japan and Korea, which results in a natural bias of this fund towards the East. The importance of Asia is continuing to grow as the centre of financial markets gravitates towards China. We believe Antipodes is the Australian manager best placed to provide outsized returns from this transition and that this will provide substantial diversification.

What does it invest in?

The fund is high conviction, expected to hold between 30 and 60 individual companies, has a focus on capital preservation and the requirement for a ’margin of safety’ in all investments. They also take an active approach to managing currency, understanding that obvious under and overvaluations can be used to boost returns over the long-term.

The fund has a highly diversified portfolio and varies substantially from the MSCI Index which holds around 60% in US equities. The current geographic exposure is as follows:

Importantly, the funds net exposure, which is the combination of their long positions less their short positions, is just 63%.

The largest current holdings are similarly spread across the globe with five highlights being:

  • Facebook: They were attracted to Facebook’s underwhelming valuation following the anti-trust and privacy issues that arose in 2018 and remain focused on the huge usage growth that continues to deliver on each of Facebook’s platforms. Most importantly, they highlight that Facebook has stopped thinking about ‘safety’ and is once again embarking on major innovation projects including e-commerce, digital currency which should lead to further monetization.
  • Siemens: Antipodes see value in Siemens recent change in strategy. The company spent many years dragging down European indices as management sought to acquire every business possible but struggled to combine disparate units in a profitable way. Due to investor pressure the company is now simplifying and releasing substantial value to investors, with the sale of its European power assets a particularly positive decision. The company continues to hold strong positions in important sectors like automation hardware and software which they believe are undervalued.
  • Samsung: Samsung fits into the computing/connectivity bucket in the portfolio due to its substantial operations in manufacturing semi-conductors, batteries and flash memory for the likes of Apple, Sony and Nokia. Antipodes believe the company was oversold due to macro issues like the trade war and the complex generational ownership transfer occurring in Korea. They see substantial value in the operating business, supported by strong demand from key customers whilst the modernization of Korea will see increasing dividends and shareholder returns via buyback.
  • Alibaba: Alibaba is an incredible business, being the dominant business to business and business to consumer e-commerce provider in China. The company operates the successful T-Mall and Tao Bao sites among many other businesses. Alibaba was established as an online version of the wholesale markets that occur all over China and has successfully evolved numerous times in the face of increasing competition from outside and within China. The company’s investment in Ant Financial which dominates the online payment landscape in China, offers further upside as it continues to expand into investment, insurance, credit and other financial products.
  • Tesla: Tesla is a high profile short of Antipodes selected on the basis that the company has been over hyped as a ‘disruptor’ and will have little chance of delivering on inflated expectations. This position has been profitable and is expected to generate further returns as the likes of BMW and Mercedes-Benz launch much anticipated electric models in the coming months.

How has it performed?

The short-term performance has been weak adding just 2.6% over the 12 months to 30  June but long-term returns are solid at 10.5% per annum since inception, slightly above the benchmark. The fund’s weak short-term performance has been due to an overweighting to Chinese and other Asian technology companies which fall within the Connectivity / Compute and Online services clusters, but which have been hit by the US-China trade escalations. The Software investment, including Microsoft, and simplifying Industrial Conglomerates like Siemens added to returns. Importantly, this is a long-short fund which has carried substantially less exposure to the market, at just 60%, meaning the returns have been delivered at lower volatility and risk.

What income does it provide?

As with all managed funds, the Antipodes Global Fund must distribute all income and realised capital gains each year. Therefore, distributions are dependent on both the performance of the underlying investments and whether any investments are actually sold. As an actively managed strategy the fund receives minimal dividends and the majority of returns come in the form of capital growth and realised gains. The distributions since inception in 2015 are as follows and have averaged around 4% per annum with the intention to be paid semi-annually:

  • 2015-16 – 3.16 cents per unit (2.33%)
  • 2016-17 – 2.18 cent per unit (1.35%)
  • 2017-18 – 9.24 cents per unit (5.37%)
  • 2018-19 – 9.04 cents per unit (5.42%)

A golden era for active managers is coming

By Russel Pillemer, Pengana Capital

“It is not a stretch to imagine the next 10 years will be a golden age for Australian active managers”.

The constant barrage of reports about the demise of the active fund manager is relentless. The average investor might conclude the age of active is over and it’s time to switch to low cost index-type solutions. However, more informed investors understand nothing could be further from the truth.

The coming years are likely to be a golden era for active managers. It is highly improbable the next decade will be a repeat of the last decade’s smooth sailing. Over the past 10 years, markets have experienced an incredible run with indices soaring. Momentum has been a key driver, and in times like these, fundamentals hardly matter, leading active managers to struggle to outperform.

There were many active managers who were, in reality, closet index managers. As the cost of index funds has decreased significantly, many of these managers have lost clients and been forced to close – and rightfully so.

Meanwhile, there has been a proliferation of active, with many raising too much money. It’s a well understood phenomena that if a fund manager manages too much money (relative to the size of their market) they will be unable to perform well.

Asset gatherers are insufficiently incentivised to outperform.

Many of the large Australian institutional investors withdrew from active managers and moved to index funds. Either they consider low fees to be their primary objective (with returns being a distant second), or alternatively they have defined risk as the divergence of returns from the index, rather than the risk of losing capital. This reasoning makes sense in a bull market, where index products have outperformed high-cost active strategies. However, it is patently obvious this is nonsensical in a sideways or downwards market.

It is not a stretch to imagine the next 10 years will be a golden age for Australian active managers.

Due to the large number of closures and losses of mandates, there is far less competition for fundamental trades. This is particularly significant for small and mid-cap companies, which includes almost all of the Australian market.

And passive index-style strategies are ideal counterparties for active managers who can identify mis-pricing opportunities that index strategies create by virtue of their “dumb” trading rules.

Survive and thrive

The index trade is overcrowded. We know this as so many investors have capitulated and moved to index-type solutions. But history teaches us that overcrowded trades will inevitably unwind. Finally, active managers tend to thrive in volatile markets – and while it would be foolish to attempt to predict the direction of the markets over the next decade, it is reasonable to assume that volatility will be higher.

Investors need to identify active managers that are well-positioned to survive and thrive.

Look for highly skilled teams or individuals with substantial experience and proven track records. Ensure they have stuck to their guns and not surrendered their investment style to pressures emanating from the extended bull market. A credible manager will construct their strategies with an interest in downside protection and limit the amount of money they are willing to accept. I would add that such a manager defines risk as in “the risk of losing money” not “the risk of divergence from the market return”.

Good fund managers should be backed by appropriately resourced businesses so they are not faced with existential risks or operational complexity. Critically, they should not be hostage to large institutional investors who pose undue concentration risks. While the investing masses are piling into low-cost index-type solutions, the smart money is seeking alternative managers with the above attributes.

These intelligent investors are predicting a very different decade ahead and focused on securing allocations in expert managers. Investors who are doing this are likely to be handsomely rewarded over the coming years. Investors who are opting for low-cost solutions will inevitably realise the cheap lunch is likely to cost them dearly.

Pinebridge Global Dynamic Asset Allocation Fund

What’s the fund?

This month we are taking a closer look at the Pinebridge Global Dynamic Asset Allocation Fund. The fund is a multi-asset strategy that was originally established to manage the assets of the AIG insurance statutory fund. Statutory funds are similar to a typical pension fund in that they are required to generate consistent returns to meet the regular drawdowns that result from insurance claims. The fund targets a return of CPI + 5.00% per annum regardless of market returns and achieves this by focusing on asset allocation rather than investment selection.

The strategy is quite straightforward in that the 20-strong multi-asset team of $50bn work constantly to determine the risk and return outlook for every asset class in the world. The multi-asset team understand that economic trends in the short (within 12 months) and long-term (over 5 years) are incredibly difficult to predict. In their experience, the greatest level of certainty and actionable trends falls in the medium term, 2-3 years; as a result, they focus their analysis on building a model of economic inputs and review this quarterly. These expectations form the basis of forecast returns for all major asset classes (in the form of a Capital Markets Line) and underlying sectors of the economy. The results are plotting against each other at which point the management team allocate capital to the most attractive sectors on a risk to reward basis.

Where does it fit in your portfolio?

The Pinebridge Global Dynamic Asset Allocation Fund (GDAAF) targets a return of CPI + 5.00% over rolling three-year periods. This meets the return requirement of the Targeted Return Bucket. Importantly, the funds mandate is to deliver this whilst exposing the portfolio to two thirds the volatility of equity markets and through a highly diversified selection of assets. The fund reduces risks by investing into a series of exchange traded funds (ETFs), external and internal managed funds in order to gain its exposure to the various sectors of global markets. The strategy has outperformed its benchmark over the very long-term and most importantly been able to restrict losses during all major market events. Given the fund has a target of 2/3rds the volatility of sharemarkets, this is one of the more growth oriented Targeted Return strategies, meaning it complements well with the lower risk Smarter Money and Invesco funds.

Why invest?

Extensive research has shown that asset allocation drives a large portion of long-term returns and importantly, that simply maintaining the same asset allocation over time is not sufficient to deliver on the typical CPI + 4.0% objective of most investors and pension funds. In fact, research by Dalbar Inc. found that in order to generate this return over extended period and in different conditions, an investor would need to hold 100% equities at some times and 100% bonds at others. Obviously, this is extremely difficult to implement.

We are more concerned that the 30 year compression in bond rates will come to an end soon and that the historic levels of Quantitative Easing may have brought forward sharemarket returns for the next decade. We have undertaken substantial research in order to identify the asset classes that are able to protect your portfolio in what we believe will be either sustained low bond rates or a rising bond rate environment; both scenarios are not great for equity investors. We came to the conclusion that applying a more dynamic approach to asset allocation; that seeks to benefit from medium term opportunities offers the best potential to achieve this.

What does it invest in?

As detailed above, the fund invests into a combination of ETF’s and managed funds both internally managed by different parts of the Pinebridge team or those offered by external managers; the key being the team has more time to focus on value adding asset allocation decisions. The largest holdings at the current time are as follows:

  • Productivity Basket: The Productivity Basket was established by Pinebridge to capture the huge increase in investment that was expected and continues to occur around the world. Their research highlighted substantial underinvestment by business and sought to build an active portfolio of exposures to this important growth sector of the global economy. The underlying allocations are as follows:

 

  • US Small Cap Equity: Pinebridge have a generally positive view for the US economy believing that fiscal and monetary conditions facilitate a further extension of the cycle and that the current slowdown in economic data will be short-lived. The result is that their Capital Markets Line suggests US smaller companies offer greater risk adjusted returns due to the higher exposure to the true US economy and substantially cheaper valuations than the mega cap S&P 500 constituents.

 

  • US Government Bonds: The fund has increased its exposure to US Government Bonds from 5.5% to 8.6% during the quarter as they grew more confident in the prospect of rate cuts to stimulate the economy and believe that the large amount of Government debt necessitates lower rates for longer. This has added protection for investors in periods of volatility.

 

  • Japan Equity: Management have a long-held view of two things in Japan; 1) Abenomics will continue for the foreseeable future and eventually be successful in stimulating growth; 2) Japanese companies would become more shareholder focused. The combination has performed well for investors, with many Japanese indices now focused on the Return on Equity and cash returned to shareholders rather than on reinvestment of profits.

 

  • Indian Equity: Pinebridge’s global network means they have in-country analysis teams in most important markets, with India a case in point. The team in India have delivered one of the best performing domestic equity funds in the world and were able to successfully foresee the implications of Modi’s run to Government and subsequent reform agenda to the benefit of investors. This offers a differentiating point and an exposure that is very difficult for investors to access.

How has it performed?

Pinebridge has successfully navigated the worst market events over the last 20 years via its conviction to its asset allocation approach. This affords management the ability to increase cash, bond and other fixed interest weightings when the Capital Markets Line suggests they offer better risk-adjusted returns. Importantly, their models suggested this was the case prior to both the Dot Com Bubble and the Global Financial Crisis, triggering a substantial move into low risk assets at just the right time.  

The fund has only been available to retail investors in Australia since 2015, but the wholesale class has returned 6.94% since inception with $1.43bn under management here. This is in line with the CPI + 5% benchmark but delivered with substantially lower volatility. Shorter term performance has been weaker, due to the higher growth allocation to the Productivity Basket with a 3.07% return for the 12 months to 30 June.

What income does it provide?

As with all managed funds, the Pinebridge Global Dynamic Asset Allocation Fund must distribute all income and realised capital gains each year. Therefore, distributions are dependent on both the performance of the underlying investments and whether any investments are actually sold. As an actively managed strategy the fund receives minimal dividends and the majority of returns come in the form of capital growth and realised gains. The distributions since inception in 2015 are as follows and have averaged around 5% per annum with the intention to be paid semi-annually:

  • 2014-15 – 4.93 cent per unit
  • 2015-16 – .03 cents per unit
  • 2016-17 – 5.84 cents per unit
  • 2017-18 – 5.04 cents per unit

Importantly for investors, the fund provides daily liquidity and charges a management expense ratio of 1.00%.