Archive for category: Managed Accounts

After a decade of record-low bond yields, fixed income has been making a comeback this year. In Australia, when advisers and investors think of fixed income, they mostly think of term deposits and government bonds, but corporate bonds also make up a significant portion of the global bond market. The global bond market is massive – bigger than the global share market – with different grades of issuers, companies, terms, and structures.

Bond fundamentals

Before we look at the outlook for the corporate bond market, here are some bond fundamentals for you and your clients:

• Bonds are credit instruments – companies and governments issue bonds as a way of raising money, borrowing funds from investors in the form of bonds.
• Bonds are usually issued for a fixed term – between one and thirty years. Maturity is the term for which the bond is issued.
• When you purchase a bond, the bond issuer is legally obliged to pay you regular interest, referred to as coupons. Coupons are usually set at a fixed rate, paid to the bond holder at regular intervals. This is why they are also called fixed income.
• Bonds are issued with a face value that is to be repaid to the bondholder at maturity. The full face value is referred to as Par and is usually $100.
• As interest rates go up, bond prices decline. This is because interest rates are used to discount the bond cash flows to arrive at the bond’s price. So, if the denominator goes up and the coupon which is the numerator remains fixed, the prices will decline.
• Duration and Maturity are not the same thing. When we talk about Duration, we talk about the sensitivity of the bond prices to interest rates. Generally, bonds with long maturities and low coupons have the longest durations. These bonds are more sensitive to a change in market interest rates and thus are more volatile in a changing rate environment.
• Corporate Bonds carry a rating from one of three big ratings agencies – S&P Global, Moody’s, and Fitch. Investment-grade bonds (with a rating of BBB-/Baa3 and above) have relatively lower risk and lower returns as they have a stronger payment capacity compared to High Yield or below-Investment grade bonds.
• It is important to remember that, unlike government bonds, corporate bonds do not carry the guarantee of a government and therefore investors’ money is at risk. However, corporate bonds have a lower risk than shares in the same company as they sit higher on the capital preservation ladder. This means that if your bond issuer becomes insolvent, you will have priority over hybrid and equity investors when the proceeds of asset sales are applied.

 Outlook for the corporate bond market

We see two major factors impacting the short to mid-term outlook for corporate bonds – ongoing stress from higher interest rates and the cost of refinancing.

Ongoing stress from higher interest rates

Central banks are close to the end of their current hiking cycle but this “higher for longer” mantra may be a cause of ongoing stress for some corporate bonds. While in most cases, a pause in rate rises is good for risk assets with an initial rally as they have a stronger payment capacity, this time, the current economic landscape is not conducive to a sustained rally.

We are faced with credit tightening, banking client concerns, sticky inflation, and yield curves that have flattened locally and deeply inverted in the USA. An inverted yield curve is unusual and does not happen often which means that the yield on shorter maturity bonds is higher than longer maturity bonds.

In addition, lower-quality corporate bond issuers such as high-yield corporate bonds are at a higher risk of default because higher interest rates will mean they will need operational revenues and minimal cost increases in order to cover interest costs. With corporate debt maturities coming up within the next year, many of these issuers are going to find it difficult to roll over or even refinance their debt obligations.

Cost of refinancing

The bond maturity wall for US Corporate Bonds has been pushed out by several years, especially for high-yield bonds, making refinancing manageable for now. However, if the US Federal Reserve keeps rates higher for an extended period of time, there is a lot of debt that will need to be refinanced at higher levels than most of these companies have ever seen, or at least experienced in decades. It is worth noting that Australian companies do issue a lot of debt in the US market. This may have an effect here whereby the cost of refinancing may see Australian corporates return to Australia to refinance their debt thereby pushing up domestic corporate credit yields.

USD bond maturity wall

Allied to the bonds maturity wall, the global tightening of bank lending standards will have a knock-on effect for lower grade bonds wanting to refinance. We expect lending standards to remain tight into the next year so if these lower-grade borrowers can’t raise funds in the corporate bond market to refinance their bonds, turning to banks will not be much of an option.

Major US investment banks expect High Yield defaults to revert to the long-run average. of around 4% to 5%, lower than previous crisis/recession levels and higher than current levels of less than around 1%. This may also cause, a longer period of defaults, particularly if the US Federal Reserve decided to hold rates higher for longer.

In summary, the outlook for corporate bonds in a higher for longer rate cycle and the credit-tightening environment now has elevated risks but you are now being compensated with much higher running yields. For example, in a two-year US high-yield corporate bond the yield is now approximately 8.88%*, made up of 4.98% government bond yield plus 3.90% spread. The long-term high yield spread average is 5.4% and for recessionary periods 8% above government bond yields. Given current corporate credit fundamentals, spreads are expected to at least move back toward their historical long-term average.

*as at 6 July 2023

IMPORTANT NOTICE: This document is published by Lonsec Investment Solutions Pty Ltd ACN 608 837 583, a Corporate Authorised Representative (CAR 1236821) (LIS) of Lonsec Research Pty Ltd ABN 11 151 658 561 AFSL 421 445 (Lonsec Research).  LIS creates the model portfolios it distributes using the investment research provided by Lonsec Research but LIS has not had any involvement in the investment research process for Lonsec Research. LIS and Lonsec Research are owned by Lonsec Holdings Pty Ltd ACN 151 235 406. Please read the following before making any investment decision about any financial product mentioned in this document.

DISCLOSURE AT THE DATE OF PUBLICATION: Lonsec Research receives a fee from the relevant fund manager or product issuer(s) for researching financial products (using objective criteria) which may be referred to in this document. Lonsec Research may also receive a fee from the fund manager or product issuer(s) for subscribing to research content and other Lonsec Research services.  LIS receives a fee for providing the model portfolios to financial services organisations and professionals. LIS’ and Lonsec Research’s fees are not linked to the financial product rating(s) outcome or the inclusion of the financial product(s) in model portfolios. LIS and Lonsec Research and their representatives and/or their associates may hold any financial product(s) referred to in this document, but details of these holdings are not known to the Lonsec Research analyst(s).

WARNINGS: Past performance is not a reliable indicator of future performance. Any express or implied rating or advice presented in this document is limited to general advice and based solely on consideration of the investment merits of the financial product(s) alone, without taking into account the investment objectives, financial situation and particular needs (“financial circumstances”) of any particular person. Before making an investment decision based on the rating or advice, the reader must consider whether it is personally appropriate in light of his or her financial circumstances or should seek independent financial advice on its appropriateness.  If the financial advice relates to the acquisition or possible acquisition of a particular financial product, the reader should obtain and consider the Investment Statement or the Product Disclosure Statement for each financial product before making any decision about whether to acquire the financial product.

DISCLAIMER: No representation, warranty or undertaking is given or made in relation to the accuracy or completeness of the information presented in this document, which is drawn from public information not verified by LIS. The information contained in this document is current as at the date of publication. Financial conclusions, ratings and advice are reasonably held at the time of publication but subject to change without notice. LIS assumes no obligation to update this document following publication. Except for any liability which cannot be excluded, LIS and Lonsec Research, their directors, officers, employees and agents disclaim all liability for any error or inaccuracy in, misstatement or omission from, this document or any loss or damage suffered by the reader or any other person as a consequence of relying upon it.

Copyright © 2023 Lonsec Investment Solutions Pty Ltd ACN 608 837 583 (LIS). This document may also contain third party supplied material that is subject to copyright.  The same restrictions that apply to LIS copyrighted material, apply to such third-party content.

Inflation is likely to ease substantially in the coming months as base effects roll off and tighter credit conditions hit consumption and aggregate demand. Services inflation, rent rises and wage pressures however persist, meaning inflation could remain sticky and above central bank target ranges for some time. Financial conditions are therefore likely to remain tight as central banks keep a foot on the brake while managing pockets of stress via targeted liquidity support. Domestically, a large number of home borrowers will roll off ultra-low fixed rate home loans onto significantly higher mortgage rates in the coming months. This means there is more tightening to come for the Australian household sector irrespective of how much higher the RBA takes the cash rate.

Consumer confidence remains weak both here and in the US, and with the cash buffers built up during the pandemic largely eroded, signs that economic growth has begun to slow have emerged. US GDP came in well below expectations at +1.1% (annualised) for the first quarter.

The ongoing debate on raising the US debt ceiling, while closer to resolution at the time of writing, is not yet a done deal and represents additional left-tail risk to an already clouded outlook. Our base case is that this issue will be resolved, allowing the US government to meet its financial obligations. However, the combative nature of the current US political arena means a stalemate cannot be ruled out entirely. Failure to reach agreement would have severe ramifications across equity, bond and currency markets.

On a positive note, valuations are looking more appealing across a range of asset classes. Australian equity valuations are almost looking as attractive as they were during the peak stresses of the pandemic on a P/E basis. Tight financial conditions coupled with a weakening cyclical environment lead us to believe that the second half of 2023 continues to present some headwinds for risk assets notwithstanding the more attractive valuations we are seeing.

We remain cautious, and close to benchmark with a slight underweight in global equities. In the current environment, a focus on quality investments, liquidity, active portfolio management, diversification and risk control become even more critical for portfolio constructors. We continue to monitor developments regarding inflation, monetary policy and the global economy, and will adjust our portfolios, as necessary, to navigate through the challenges and opportunities ahead.

IMPORTANT NOTICE: This document is published by Lonsec Investment Solutions Pty Ltd ACN 608 837 583, a Corporate Authorised Representative (CAR 1236821) (LIS) of Lonsec Research Pty Ltd ABN 11 151 658 561 AFSL 421 445 (Lonsec Research).  LIS creates the model portfolios it distributes using the investment research provided by Lonsec Research but LIS has not had any involvement in the investment research process for Lonsec Research. LIS and Lonsec Research are owned by Lonsec Holdings Pty Ltd ACN 151 235 406. Please read the following before making any investment decision about any financial product mentioned in this document.

DISCLOSURE AT THE DATE OF PUBLICATION: Lonsec Research receives a fee from the relevant fund manager or product issuer(s) for researching financial products (using objective criteria) which may be referred to in this document. Lonsec Research may also receive a fee from the fund manager or product issuer(s) for subscribing to research content and other Lonsec Research services.  LIS receives a fee for providing the model portfolios to financial services organisations and professionals. LIS’ and Lonsec Research’s fees are not linked to the financial product rating(s) outcome or the inclusion of the financial product(s) in model portfolios. LIS and Lonsec Research and their representatives and/or their associates may hold any financial product(s) referred to in this document, but details of these holdings are not known to the Lonsec Research analyst(s).

WARNINGS: Past performance is not a reliable indicator of future performance. Any express or implied rating or advice presented in this document is limited to general advice and based solely on consideration of the investment merits of the financial product(s) alone, without taking into account the investment objectives, financial situation and particular needs (“financial circumstances”) of any particular person. Before making an investment decision based on the rating or advice, the reader must consider whether it is personally appropriate in light of his or her financial circumstances or should seek independent financial advice on its appropriateness.  If the financial advice relates to the acquisition or possible acquisition of a particular financial product, the reader should obtain and consider the Investment Statement or the Product Disclosure Statement for each financial product before making any decision about whether to acquire the financial product.

DISCLAIMER: No representation, warranty or undertaking is given or made in relation to the accuracy or completeness of the information presented in this document, which is drawn from public information not verified by LIS. The information contained in this document is current as at the date of publication. Financial conclusions, ratings and advice are reasonably held at the time of publication but subject to change without notice. LIS assumes no obligation to update this document following publication. Except for any liability which cannot be excluded, LIS and Lonsec Research, their directors, officers, employees and agents disclaim all liability for any error or inaccuracy in, misstatement or omission from, this document or any loss or damage suffered by the reader or any other person as a consequence of relying upon it.

Copyright © 2023 Lonsec Investment Solutions Pty Ltd ACN 608 837 583 (LIS). This document may also contain third party supplied material that is subject to copyright.  The same restrictions that apply to LIS copyrighted material, apply to such third-party content.

It sounds like a cliché but there is never a dull moment in markets. Not too long ago most people were unaware of what SVB (Silicon Valley Bank) was, including me. Today everyone is an expert with reems of analysis as to where it all went wrong! It has been a tumultuous month for markets starting with several small/mid-sized banks in the US shutting down and depositors redeeming their money as questions about the viability of these banks gained momentum. This was topped off with one of the cornerstone establishments of Swiss banking Credit Suisse being bought out by UBS to avoid a banking collapse and possible contagion across the global banking sector. The story didn’t end there as Credit Suisse AT1 debt holders (equivalent to Australian hybrids) got wiped out with assets being written down to zero while equity holders retained some value. This put the whole notion of the capital structure into question where debt holders are meant to rank above equity holders which created more volatility in markets and forced the European Central Bank and the Bank of England to come out to reassure markets by stating that the traditional capital structure remains true and that the Credit Suisse AT1 debt issue is isolated to Switzerland’s unique banking rules.

For many the current banking melodrama is invoking bad memories of the global financial crisis (GFC) of 2008. It is important to note that the banking sector has significantly de-risked since 2008 notably in terms of Tier 1 capital ratios which have increased substantially since 2008 following the Basel III banking framework which was brought in post the GFC in order to strengthen the banking system. One of the issues with banks such as SVB was a lack of governance and oversight by the US regulator, which contrasts with the Australian banking sector which has largely adopted the Basel III requirements. Another notable difference from the GFC was that central banks reacted quickly to the current crisis, unlike in 2008 where central banks dragged their heels until the banking system was on the verge of breaking.

So, are we out of the woods? It seems that the swift action of central banks has settled markets for now. The broader risk remains contagion and like many significant events in history while they don’t necessarily repeat, they do rhyme and I have no doubt that there are many nervous bankers out there taking a good look at their business models and capital reserves.

From a practical perspective we would expect the cost of debt to rise as a result of the banking issues. There is a view that this would in effect be the equivalent of two rate hikes and that it may trigger central banks to take a more dovish stance in raising rates to fight inflation. To date there is no evidence of this and central banks commentators have tried to delineate between stability of the system and inflation. However, one cannot dismiss the notion that the rapid rise in rates has exposed cracks in the markets with the current banking issues an example of this.

IMPORTANT NOTICE: This document is published by Lonsec Investment Solutions Pty Ltd ACN 608 837 583, a Corporate Authorised Representative (CAR 1236821) (LIS) of Lonsec Research Pty Ltd ABN 11 151 658 561 AFSL 421 445 (Lonsec Research).  LIS creates the model portfolios it distributes using the investment research provided by Lonsec Research but LIS has not had any involvement in the investment research process for Lonsec Research. LIS and Lonsec Research are owned by Lonsec Holdings Pty Ltd ACN 151 235 406. Please read the following before making any investment decision about any financial product mentioned in this document.

DISCLOSURE AT THE DATE OF PUBLICATION: Lonsec Research receives a fee from the relevant fund manager or product issuer(s) for researching financial products (using objective criteria) which may be referred to in this document. Lonsec Research may also receive a fee from the fund manager or product issuer(s) for subscribing to research content and other Lonsec Research services.  LIS receives a fee for providing the model portfolios to financial services organisations and professionals. LIS’ and Lonsec Research’s fees are not linked to the financial product rating(s) outcome or the inclusion of the financial product(s) in model portfolios. LIS and Lonsec Research and their representatives and/or their associates may hold any financial product(s) referred to in this document, but details of these holdings are not known to the Lonsec Research analyst(s).

WARNINGS: Past performance is not a reliable indicator of future performance. Any express or implied rating or advice presented in this document is limited to general advice and based solely on consideration of the investment merits of the financial product(s) alone, without taking into account the investment objectives, financial situation and particular needs (“financial circumstances”) of any particular person. Before making an investment decision based on the rating or advice, the reader must consider whether it is personally appropriate in light of his or her financial circumstances or should seek independent financial advice on its appropriateness.  If the financial advice relates to the acquisition or possible acquisition of a particular financial product, the reader should obtain and consider the Investment Statement or the Product Disclosure Statement for each financial product before making any decision about whether to acquire the financial product.

DISCLAIMER: No representation, warranty or undertaking is given or made in relation to the accuracy or completeness of the information presented in this document, which is drawn from public information not verified by LIS. The information contained in this document is current as at the date of publication. Financial conclusions, ratings and advice are reasonably held at the time of publication but subject to change without notice. LIS assumes no obligation to update this document following publication. Except for any liability which cannot be excluded, LIS and Lonsec Research, their directors, officers, employees and agents disclaim all liability for any error or inaccuracy in, misstatement or omission from, this document or any loss or damage suffered by the reader or any other person as a consequence of relying upon it.

Copyright © 2023 Lonsec Investment Solutions Pty Ltd ACN 608 837 583 (LIS). This document may also contain third party supplied material that is subject to copyright.  The same restrictions that apply to LIS copyrighted material, apply to such third-party content.

As the saying goes, “what a year!” As the world slowly emerged out of Covid lockdowns, two central themes have dominated 2022, inflation and geopolitics. Domestically the annual CPI figure has exceeded 7%. It has been a similar story across most economies globally as a cocktail of years of low interest rates, central bank driven liquidity in the form of quantitative easing, severe supply chain disruptions caused by Covid lockdowns and the Russian invasion of Ukraine placing pressure on commodity prices have all contributed to the current inflationary environment. As a result, interest rates have gone up with key central banks committed to raising rates until inflation shows signs of abating. The rising interest rate environment has fueled volatility in markets with no asset class spared as assets have repriced for the higher interest rate environment. Needless to say, it has been a challenging time for diversified portfolios as equities and bonds have both sold off.

Additionally, as the market has tried to digest the prospect of higher inflation, we also witnessed a sharp rotation into sectors and stocks that were viewed as being beneficiaries of higher inflation such as energy stocks, with sectors such as healthcare and technology selling off irrespective of the quality of the company.

Despite the challenging market environment there have been some bright spots. Alternative assets have generally benefited from the increased market volatility and dispersion in returns. Unlike traditional assets, higher volatility is more conducive to alternative strategies such as relative value approaches as they can exploit market inefficiencies. Value-based investment approaches have also turned around a decade of underperformance relative to growth-style investing as growth stocks, which are viewed as longer duration assets, have been sold off. We have also seen many active approaches able to add value in this challenging period for markets as active investment managers have been able to sift through the market as asset have indiscriminately sold off. Finally, bonds which have been difficult to invest in for years due to the low interest rate environment are beginning to show signs of value as bond yields have risen.

In 2023 the themes of inflation and heightened geopolitical risk are expected to continue to be key focal points. However, the narrative will increasingly focus on the prospect of a recession as the impact of higher interest rates makes its way through the economy impacting households and ultimately demand which we expect will make its way to corporate earnings by Q3 in 2023. At this stage our base case is not for a deep recession in Australia. However, on a global level Europe remains at greater risk of a deep recession as high inflation combined with energy security concerns resulting from geopolitical risks associated with the war in Ukraine continue to impact European markets. Central banks appear to be comfortable with the prospect of a recession as long as inflation is controlled. Against this backdrop we have been gradually neutralising our key active asset allocation exposures away from risk assets in favour of bonds.

The year ahead will be challenging with markets likely to range trade. Our dynamic asset allocation has added significant value over recent years as the decision to be long equities and underweight bonds was a relatively simple one. We expect that bottom up manager and stock selection will be a greater contributor to returns in 2023 as we continue to see increases dispersion in returns within asset classes as market volatility remains.

On behalf of the Lonsec Investment Solutions team we wish everyone a peaceful festive period and we look forward to working with each of you in 2023.

IMPORTANT NOTICE: This document is published by Lonsec Investment Solutions Pty Ltd ACN 608 837 583, a Corporate Authorised Representative (CAR 1236821) (LIS) of Lonsec Research Pty Ltd ABN 11 151 658 561 AFSL 421 445 (Lonsec Research).  LIS creates the model portfolios it distributes using the investment research provided by Lonsec Research but LIS has not had any involvement in the investment research process for Lonsec Research. LIS and Lonsec Research are owned by Lonsec Holdings Pty Ltd ACN 151 235 406. Please read the following before making any investment decision about any financial product mentioned in this document.

DISCLOSURE AT THE DATE OF PUBLICATION: Lonsec Research receives a fee from the relevant fund manager or product issuer(s) for researching financial products (using objective criteria) which may be referred to in this document. Lonsec Research may also receive a fee from the fund manager or product issuer(s) for subscribing to research content and other Lonsec Research services.  LIS receives a fee for providing the model portfolios to financial services organisations and professionals. LIS’ and Lonsec Research’s fees are not linked to the financial product rating(s) outcome or the inclusion of the financial product(s) in model portfolios. LIS and Lonsec Research and their representatives and/or their associates may hold any financial product(s) referred to in this document, but details of these holdings are not known to the Lonsec Research analyst(s).

WARNINGS: Past performance is not a reliable indicator of future performance. Any express or implied rating or advice presented in this document is limited to general advice and based solely on consideration of the investment merits of the financial product(s) alone, without taking into account the investment objectives, financial situation and particular needs (“financial circumstances”) of any particular person. Before making an investment decision based on the rating or advice, the reader must consider whether it is personally appropriate in light of his or her financial circumstances or should seek independent financial advice on its appropriateness.  If the financial advice relates to the acquisition or possible acquisition of a particular financial product, the reader should obtain and consider the Investment Statement or the Product Disclosure Statement for each financial product before making any decision about whether to acquire the financial product.

DISCLAIMER: No representation, warranty or undertaking is given or made in relation to the accuracy or completeness of the information presented in this document, which is drawn from public information not verified by LIS. The information contained in this document is current as at the date of publication. Financial conclusions, ratings and advice are reasonably held at the time of publication but subject to change without notice. LIS assumes no obligation to update this document following publication. Except for any liability which cannot be excluded, LIS and Lonsec Research, their directors, officers, employees and agents disclaim all liability for any error or inaccuracy in, misstatement or omission from, this document or any loss or damage suffered by the reader or any other person as a consequence of relying upon it.

Copyright © 2022 Lonsec Investment Solutions Pty Ltd ACN 608 837 583 (LIS). This document may also contain third party supplied material that is subject to copyright.  The same restrictions that apply to LIS copyrighted material, apply to such third-party content.