Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
Fixed income: don’t forget bonds for true defence
In March and April this year, Jamieson Coote Bonds, a Melbourne boutique bond manager, suffered redemptions of about $1 billion, which were processed without difficulty. “Solvency and liquidity are what matters in the darkest days,” says partner Charlie Jamieson.
Jamieson and his big competitor PIMCO, shared a session on what to do with fixed income in the current climate at the Morningstar Investment Conference for Australasian clients. As interest rates fell and fell in the past few years, investors chased yield harder and harder. But they may have gone further out the risk curve than they intended.
Jamieson and PIMCO’s US-based Marc Seidner addressed the conference last week (October 8). Jamieson was more defensive of the defensive nature of government bonds, while Seidner could afford to be more sanguine. PIMCO is not only the world’s largest fixed income manager, it also has the broadest range of credit strategies, with risk/return profiles across the spectrum, including what amount to hedge funds.
Seidner agreed with Jamieson that investors should not underestimate the power of quality government bonds. “If yields go to zero, which is possible, you can still get an 8 per cent return,” Seidner said. “You can’t rule out the diversification benefits. When there’s a vaccine, we could go back to some sort of normal. But, meantime, there is additional high-quality income to be had, such as with high-quality credit and well-structured mortgage assets.”
He advised investors, though, to not go below investment grade, which was “the place to be”. There would likely be more defaults among non-investment grade instruments.
Jamieson said: “It’s very important to take a look to see what’s under the hood with some securities. Under duress they can behave very much like equities… As bonds head towards negative yield, they still behave like bonds. Australia is starting further back on the grid – still in positive territory – so we still have more runway ahead of us.”
He said that lack of yield was very depressing for a bond manager, but this was a common problem for all fixed income markets and markets in general. “What is defensive under duress? For us, the government bond piece is essential because it’s very liquid. We think equities are a better alternative to corporate bonds because you can still get out… Australian bonds are in a special place compared with their global peers. They are still in demand and relatively cheap. They have the two elements of carry and income and roll-downs (as five years rolls down to four and so on) and they are more important over time than duration.”
– G.B.
