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QSuper, CFS and Western seeking alpha in fixed income

Amanda White




Investors are making their fixed income portfolios work harder and are seeking alpha from managers, a panel told the Conexus Financial Fixed Income, Cash and Currency Forum.

“The primary function of fixed income in the Colonial First State portfolio is as a diversifier against equities,” said George Lin, senior investment manager at Colonial First State.

“The second function is to generate some type of return and the third purpose is to provide liquidity.

“A big part of our job is to balance those three things and that has become more difficult.”

Similarly, the CFS portfolio has evolved and there have been a number of incremental changes over the past few years.

“We exited passive sovereign bond mandates and appointed some active managers about two and a half years ago. The second change is we have increased the allocation to managers which are more active, less constrained and have larger investment universes – they have been managing those types of mandates for us for seven to eight years and have gained increasing confidence in their ability to do that.”

Lin said those managers have similar characteristics and encouraged other investors to seek those characteristics out.

“Those managers don’t rely on one single call to generate returns. Try to get managers that have a very broad investment universe and can do different types of trades. Build up the team by including people with hedge fund backgrounds and risk manage those people.”

QSuper has the dual objectives of diversification and return from its fixed income allocation. The $65 billion fund has reduced its equities allocation over the past few years and introduced a new asset class, which is a higher return seeking fixed interest allocation.

Andrew Morgan, senior portfolio manager at QSuper, said importantly this strategy is not beholden to a traditional benchmark.

“In the construction of that asset class we don’t have a traditional benchmark, we created our own so it matches in with multi asset objectives. Duration is not beholden to benchmarks, instead the duration we want is much longer.”

This new asset class has similar volatility to equities, but the overall risk of the portfolio has been reduced.

Morgan acknowledged that this won’t work as well in some environments, such as an inflation environment, but he doesn’t give that scenario a high probability of occurring.

“We continue to use fixed income for diversification and risk, but the construction has evolved and we do use other tools.”

Qsuper has recently rotated many of its country exposures and has sought countries which have some capacity to rally – and Australia stands out.

“We try to seek markets with some term premium. We look at particular points on yield curves and want performance out of roll down. We are interested in picking up hedges and in security selection we look for inflation when it can be cheap to add to the portfolio.”

Inflation is the over-riding factor in driving the equity: bond correlation, Andrew Cormack, portfolio manager, Western Asset Management told delegates.

Cormack said investors need to make bonds work harder over the next few years.

In examining what drives the equity-bond correlation and whether the recent negative correlation is likely to exist he said that the overriding factor is high and rising inflation.

“That has driven a positive relationship. Unless you believe inflation is high and rising then it is unlikely the correlation goes to one.”

His view is that over the next two to three years the correlation will be low and positive.

“It is a good environment for risk assets and equity, and for low but positive bond returns. In the US yields won’t rise faster than the forwards. Where fixed income comes into play is in the equity drawdowns, it’s consistent. Saw it most recently during Brexit. That will hold going forward. You know how it will behave in drawdowns.”

Western has a flattening position on the US yield curve, a position Cormack said will work in both bull and bear markets.