New Perspectives on Fixed Interest

Matthew Macreadie, our Head of Credit Strategy and Portfolio Management, was recently interviewed for a podcast and sat down to discuss fixed income and financial markets.

Listen to the Podcast here

When asked of Matt his views on the pros and cons of direct bonds and managed funds, he highlighted that whilst his preference is direct investment, there are times when choosing a fund to look after your fixed income portfolio does make sense; it depends on the investors’ preference and investment goals.

He highlights that direct investment allows greater control of what assets investors select and can build a specific portfolio that suits individual goals, whether around risk, return or cashflow requirements. Matt also highlights that many large funds have high exposures to banks, so, for investors who already own domestic bank stocks, their portfolio may be overweight this sector; the direct bond approach allows greater tailoring of sector allocation. Conversely, managed funds allow investors to trust the experience of a portfolio manager if they are short on time to manage a portfolio themselves, and the funds tend to have greater liquidity. Matt also emphasised the importance of understanding the associated costs for each option, as managed funds often include brokerage costs in addition to management and performance fees.

Matt commented on the real inflation premium that can be accessed through fixed income, noting that the high yield/unrated market provides more of an opportunity for investors over conventional investment-grade bonds. In his view, Green bonds offer a lower risk-return payoff due to the relative infancy of the Australian sustainable bond market, particularly when compared to the US market. He does make the differentiation that the level of capital in the high-yield (and unrated space) targeting sustainable assets has not been of the same degree or magnitude relative to investment grade. Zen Energy’s recent 13.75% secured loan was an example of such a transaction. This transaction represents a business entering an exciting transition into storage and generation, which will enhance its capacity to manage risk and optimise gross margin outcomes. For investors with the ability to conduct the appropriate credit due diligence, the returns in this renewable energy segment of the market are undoubtedly attractive.

When asked of Matt the association between purchasing direct bonds and a more concentrated portfolio with lower liquidity, he referred to the global cumulative default rates for investment-grade bonds in Australia; these default rates are incredibly low if you look at S&P’s historical studies. With IAM’s small parcel bond service, available to clients both directly and on the platform via Netwealth, HUB24, investors can access smaller bond parcels of $50,000. Those investors with $50,000 can invest in direct bonds. If the minimum amount per bond is $50,000, he would suggest buying five individual bonds for a $250,000 portfolio to achieve sufficient diversification.

Finally, when asked about his views on the current market outlook and opportunities, Matt separated these into short- and longer-term themes. In the near term, he mentioned there has been a significant change in the macroeconomic environment, and investors taking advantage of higher rates should see outsized returns via capital gains when yields begin normalising. He points out, however, that conflict in the Middle East remains the most prominent short-term risk, as the potential ramifications of this situation have not been priced into global investment markets.

Taking a longer-term approach, Artificial intelligence (AI) and the digital economic revolution will change the global economy. Matt explained that AI’s first and most significant impact will be removing repetitive administrative tasks across all industries, therefore reducing costs. Moreover, he mentioned the impacts are not limited to the technology sector or the disrupted old-school industries. Thus, bonds in specific sectors may currently be mispriced, given the impact on costs and productivity changes. He concluded by stating that holding AI and digital technology assets is a good hedge and a long-term play. Two examples of bond issuers are NextDC, which operates data centres and the theme around the digitalisation of data, and Goodman Group, which operates in the logistics sector.