Ardea Real Outcome Plus Fund

Transcription

1 Ardea Real Outcome Plus Fund ARSN APIR Code HOW0162AU Monthly Performance Report July 2017 Performance 1 1 month 3 months FYTD 1 year 3 years 5 years Inception % % % % % % % p.a. Fund Benchmark Excess Return Fixed Income Indices BBerg AusBond Bank Bill Index BBerg AusBond Govt. 0+ Yr Index Performance figures are calculated after fees have been deducted and assume distributions have been reinvested. No allowance is made for tax when calculating these figures. Past performance is not a reliable indicator of future performance. 2 The Fund benchmark is the Australian Consumer Price Index. Fund Features Defensive Real Returns: The Fund aims to deliver stable returns that protect purchasing power while also profiting from inflation surprises. It seeks to achieve this with lower risk than conventional real return funds by investing exclusively in fixed income and liquid credit markets. True Active Management: The Fund takes an active relative value investment approach that is benchmark unconstrained and not reliant on duration. This means the Fund can utilise the broadest range of opportunities to generate consistent returns irrespective of the direction of interest rates. Capital Stability: As the Fund primarily invests in high quality government securities and investment grade credit, the portfolio is very liquid, and prioritises capital preservation. Diversification: The Fund invests across a diverse range of relative value strategies to avoid concentrated risk exposures. Fund Facts Portfolio Manager Inception date 18 March 2016 Investment objective Management fee Ardea Investment Management The Fund targets a stable return in excess of inflation by investing in a diversified portfolio of high quality fixed income securities that prioritises liquidity and capital preservation. 0.60% p.a. Buy/Sell spread % / % Fund size Distribution frequency $98 million Quarterly 1

2 Sector Exposure Region Exposure Ratings Exposure 3% 2% 16% 34% 15% 1% 8% 5% 1% 27% 59% 47% 82% Govt Inflation Govt Nominal Australia Global Credit AAA AA A Credit Cash New Zealand USA BBB Other Source: Ardea, S&P Fund Commentary The portfolio s return for the month was positive despite bond yields continuing to rise in July. The portfolio generated returns from nominal and breakeven inflation curve steepening positions, while modest spread widening on Australian semi-government bond and investment grade credit holdings detracted from performance. The main risk for the portfolio continues to be further large rises in bond yields. As such, we are positioning the portfolio across a diverse range of relative value return generating opportunities to avoid overexposure to any single risk driver. To further protect against bond market stress we have added to interest rate option strategies that should benefit from an increase in volatility. With option implied volatilities having declined to record lows over the month, these types of positions that will help protect the portfolio in a tail risk event are currently cheap to implement. Market Commentary Bond Yields Drifted Marginally Higher July began with bond yields rising, driven by momentum from June's sell-off. European Union (EU) bond yields breached their 2017 highs, while USD yields were more subdued due to a soft patch in economic data. However, bond yields ended the month off their intra-month high as the fears of a hawkish central bank shift that triggered the June bond sell-off moderated somewhat over July. European Central Bank (ECB) President Draghi softened his previous rhetoric citing low inflation, the BoJ (Bank of Japan) intervened in the Japanese bond market to cap yields and Chair of the US Federal Reserve (FED), Janet Yellen reiterated that US interest rates will on gradually rise, President Trump s failure to get the Republican healthcare bill passed led markets to question the Trump 'reflation' theme and the UK posted an unexpected drop in inflation. The now familiar theme in developed markets of slowly improving economic growth vs. stubbornly low inflation remains. In Australia, the 10 year government bond yield increased 0.04% over the month to end at 2.65%, which is in the middle of the year to date range. The short end of the AUD bond curve experienced unusual volatility mid-month as minutes from the last RBA meeting revealed discussion of the new neutral nominal cash rate for the Australian economy. The RBA now estimates this to be 3.5%, which is lower than the previous estimate of 5.0%, but still higher than the current rate of 1.50%. Markets initially interpreted this as signaling a shift in policy stance toward a tightening bias but RBA officials were quick to assure that this was just a routine topic of discussion and had no implication for current policy. It's notable that while Australian bond yields rose over the past two months, breakeven inflation rates declined, which implies real bond yields have risen over this period. For example, the 10 year Australian real yield has increased 0.31% over this period to 0.82%, which represents a sizeable increase in real borrowing costs within the economy. This combined with a steepening yield curve over the same period, if 2

3 persistent could result in an unwelcome tightening of financial conditions at a time when economic growth hasn't been unequivocally strong. Recall, the June bond sell-off started in Europe when ECB President Draghi hinted at possibly reducing extraordinary monetary stimulus. This scenario can be more easily justified in Europe where real yields are currently very negative and GDP (Gross Domestic Product) growth has been on a clear upward trend for the past few years. The same cannot be said of Australia. The RBA Is Still On Hold Australian inflation data released this month showed a headline rate of 1.90%, dropping back below the RBA target range. This followed 3 consecutive quarters of increases that culminated with the 2.10% print that briefly nudged the rate into the RBA's 2-3% target range. The core CPI measure that is of more relevance to the RBA came in line with expectations. Other economic data over the month reaffirmed the theme of modestly positive growth, with retail sales improving, Chinese economic data supporting key commodity prices and the labour market showing a third consecutive month of good employment growth. However, wage inflation remains stubbornly low. The RBA kept rates on hold again at their July meeting and we continue to believe they remain on hold in the near term as offsetting risks to the outlook from low wage inflation, rising commodity prices, a stronger currency and a still firm housing market remain finely balanced. Near Term Inflation Is Benign But Longer Term Gets More Uncertain While we agree with consensus market pricing of benign near term inflation risk, we diverge on the longer term uncertainty that is not being adequately priced in. We don't view inflation as a binary outcome but rather a phenomenon that plays out across varying time horizons. This underscores the importance of broad analysis that looks through to higher order effects of changes to the economy. Using this lens, we continue to believe the inflation curve is too flat and therefore insufficiently pricing longer term uncertainty. Global labour markets are an example of a channel through which this longer term uncertainty flows. This was a topic raised by the RBA Governor in a recent speech, where he alluded to rising labour competition as one factor that may explain the puzzle of persistently low wage inflation in spite of strengthening job growth. Relating this to Australia's most recent CPI release, the detailed data highlighted steep falls in mobile data costs, which has an immediate impact on reported inflation data but also contributes to more substantial effects that play out over time. So what do cheaper mobile phone bill have to do with wage inflation? The answer lies in thinking about the higher order effects. As large volumes of data can be transferred more efficiently, segments of the labour market that were previously thought immune from outsourcing/offshoring such as healthcare services are now in play. The adoption of on-demand remote access in the healthcare industry breaks down conventional assumptions that healthcare providers need to be physically located on site and therefore their wages can now be exposed to global labour competition. This phenomenon is accelerating partly because of lower data transfer costs. Two of the top ten venture capital backed on-demand companies in the world are firms that link health care professionals to patients via video. Similarly, Australian tech start-ups such as 99designs and Expert360 have opened up the previously domestically focused professional services market (another fast growing Australian job sector) to global labour competition. So don't be surprised if the next time you visit your 'local' pharmacist the person you consult is a highly trained and experienced pharmacist based in a lower wage location thousands of kilometers away. That one offshore pharmacist can now remotely service multiple 'local' pharmacies such as yours, while the person physically in the store will be a lower paid retail employee. It's easy to imagine what this sort of dynamic would do to wage inflation in the healthcare services sector, the fastest growing employment sector in Australia. Conversely, in those remote service locations, wage inflation will likely increase as those professionals can leverage their skills across a much larger global employer pool. These sorts of higher order effects significantly complicate the analysis and therefore increase longer term uncertainty around inflation and central bank policy. As such, the inflation risk premium currently reflected in longer dated inflation linked securities is arguably too low and can be exploited via inflation bond curve or derivative positioning. Volatility Pricing Is The Rock Really So Steady? The expression 'steady as a rock' is associated with stability, steadfastness and reliability. The kinds of characteristics that fund managers like to co-opt into their firm names. The Heisenberg uncertainty principle offers another perspective as it implies that even the most tangible of everyday objects, a rock for example, that you can clearly see, hold in your hands and study in detail has, at a subatomic level, a blurriness about it that makes it impossible to measure precisely. This vagueness seems jarringly at odds with our common perception of a rock as something we can be certain about. 3

4 In financial markets uncertainty is always present, it's just the degree of it that varies. A widely followed market commentator observed this month that central banks have to " navigate an unusually fluid economic, financial, institutional and political landscape". In less eloquent terms...uncertainty is high. What is jarringly at odds with this observation is that volatility implied by pricing in various option markets has dropped to record lows. For example, the CBOE Volatility Index (VIX), which measures future volatility expectations implied in the pricing of S&P equity index options, and a similar measure for US treasury volatility (MOVE) both hit record lows this month. Much has been written to explain this abnormally low market pricing of volatility. The more widely cited possibilities include the global economic growth rebound, the rise of passive investing and extreme monetary policy forcing yield seekers to boost returns by selling options. But perhaps it's just that low volatility begets low volatility. This sort of self-reinforcing feedback loop results in option sellers, emboldened by the recent history of low volatility, being enticed into selling more options, which in turn reduces volatility further and generates profits for their short volatility strategies, in turn triggering yet more option selling. This dynamic typically works and works and works until it doesn't. To understand this, behavioural finance studies of 'recency bias' are useful. They find that investors tend to overemphasise the importance of the most recent information at the expense of using broader data sets that would yield more balanced analysis. The evidence strongly suggests that decisions skewed by recency bias usually don't turn out well. And indeed, current levels of option prices seem more anchored to the recent history of benign market conditions than the potential for future uncertainty that they are supposed to reflect. For investors with expertise in option markets, this represents a pricing inefficiency that can be exploited, not just to generate returns but also for defensive portfolio construction. Volatility strategies can be a very effective tool for fixed income managers who prioritise capital preservation. Other Relevant Items Apollo Global Management launched the largest leveraged buyout fund in history ($23.5bn), while Softbank Group has raised $93bn for a new tech investment fund, which also makes it the largest in history. The Softbank fund goes against conventional wisdom in tech investing by using significant debt. Both cases reflect a broader theme of investment funds raising record amounts for corporate debt investment at a time when central banks have begun scaling back years of unprecedented monetary stimulus, corporate leverage is already at a cyclical high point (Chart 1) and credit spreads are close to multi-decade lows (Chart 2). CHART 1 US Corporate Leverage Source: US Treasury Borrowing Advisory Committee 4

5 CHART 2 US BBB Credit Spreads Source: Bloomberg It's believed that Asian rhinoceros once lived in China but have long since been extinct. It now appears the leadership in Beijing are worried that 'grey rhinos' have made a comeback. The reference was made by the Communist Party newspaper, People's Daily, in relation to financial stability risks posed by large Chinese corporates that have experienced rapid debt fueled growth. As part of the broader focus on leverage in the economy, officials warned that these large, heavily indebted conglomerates (the 'grey rhinos') need to scale back leverage. This represents a broadening of the scope of President Xi's financial risk focus from real estate and local government debt to corporate leverage. Just one example of the potentially far reaching consequences of this initiative is conglomerate Dalian Wanda Group being compelled to dispose of Australian property development projects totaling almost AUD2bn. The ECB released data showing its balance sheet has now grown to EUR4.2trn, which exceeds Germany's GDP and equates to a quarter of total EU GDP. Unlike the US FED, whose balance sheet currently totals USD4.5trn, the ECB's balance sheet contains substantial holdings in higher risk assets such as corporate credit. These numbers are becoming more relevant as ECB President Draghi is beginning to hint at the prospect of reducing stimulus, while the US FED has been more explicit in mentioning September as a possible start date for its balance sheet reduction. Arguably, the one variable that has correlated more strongly than anything else with the rise in global asset prices since 2009 is the size of central bank balance sheets. Central banks will need to tread very carefully to scale back their grand monetary experiment without triggering a wave of unintended consequences. 5

6 Contact For further information, please contact: Fidante Partners Investor Services P: E: W: For Financial planner enquiries, please contact: Your local Business Development Manager or E: For institutional enquiries, please contact: David Cubbin Institutional Business Development Manager Fidante Partners P: E: Unless otherwise specified, any information contained in this publication is current as at the date of this report and is provided by Fidante Partners Limited (ABN , AFSL ) (Fidante Partners), the issuer of the Ardea Real Outcome Fund (ARSN ) (Fund). Ardea Investment Management Pty Ltd (ABN ) (Ardea) is the investment manager of the Fund. Information in this publication should be regarded as general information only rather than advice. It has been prepared without taking account of any person s objectives, financial situation or needs. Because of that, each person should, before acting on any such information, consider its appropriateness, having regard to their objectives, financial situation and needs. Each person should obtain the relevant Product Disclosure Statement (PDS) relating to the Fund and consider that PDS before making any decision about the Fund. A copy of the PDS can be obtained from your financial adviser, our Investor Services team on , or on our website If you acquire or hold the product, we and/or a Fidante Partners related company will receive fees and other benefits which are generally disclosed in the PDS or other disclosure document for the product. Neither Fidante Partners nor a Fidante Partners related company nor our respective employees receive any specific remuneration for any advice provided to you. However, financial advisers may receive fees or commissions if they provide advice to you or arrange for you to invest in the Fund. Ardea, some or all Fidante Partners related companies and directors of those companies may benefit from fees, commissions and other benefits received by another group company. 6