31 Aug Fund Manager Focus – Schroder Fixed Income Fd
Our Fund Manager Focus Newsletters focus on a fund manager within our investment portfolio and provide information to help our clients understand their investment philosophy and outcomes.
This newsletter focuses on The Schroder Fixed Income Fund.
The past year has seen equity type investments provide significant positive returns. We are of course thankful for this, but it is easy to forget that the above average returns experienced are but the opposite side of the ‘volatility’ coin. We are generally only concerned about capital volatility when it is moving against us. In context of the past 5 – 6 years, we can recognise that the rate of return on growth assets will vary considerably, but will hopefully provide an acceptable level of average returns over the long term.
Defensive investments, such as fixed interest, serve two purposes. They provide steady income and provide capital protection. The level of capital security you require will determine your relative exposure to defensive assets, compared to growth assets. This obviously becomes more important when you retire, and your opportunity to recover from short term losses is limited. Your need to draw down on your retirement assets further exacerbates this problem. While fixed interest investments provide a lower level of capital volatility, some variation in capital is to be expected. This is because all assets are generally marked to market each day, i.e. the portfolio is valued at the price at which it could be sold each day. One of the main determinants of this price is the change in market interest rates each day.
When constructing the defensive portion of your portfolio, capital security is foremost in our considerations. This leads us to select a range of active managers who are either specialist in a particular subsector of interest rate products, or run a portfolio of assets diversified across the various fixed interest subsectors. These subsectors can include cash, Government bonds, corporate bonds and hybrids. We will generally recommend a higher exposure to diversified funds to allow for more targeted and active management of assets across these subsectors. These funds are also more able to manage what is known as ‘duration risk’. In short, duration risk describes the degree to which the value of an asset changes in response to changes in interest rates. In very broad terms, rising interest rates negatively affect the capital value of a fixed interest asset and vice versa.
About the Manager
Schroder Investment Management Australia is a part of the Schroder Asset Management Group. Established in London in 1804, the group now manages over $300 billion in assets across 32 countries, and employs over 2,700 staff. Schroder Investment Management Australia has been providing asset management services in Australia since 1962.
The Schroder Fixed Income Fund was established almost 10 years ago and is managed by Simon Doyle. While the fund can invest on a global basis, the emphasis tends to be towards Australian Fixed Interest.
The managers have a fundamental view that fixed income is generally held for defensive purposes. This includes capital preservation and the ability to diversify equity risk. In regards to capital volatility, the manager does not see this as a risk per se. They prefer to consider risk in absolute terms i.e. losing money.
The fund strategy involves constructing a core portfolio and adding value by identifying opportunistic and thematic investment ideas. These can include credit risk management, country selection and duration risk. The fund aims to outperform the UBS Composite Bond Index over the medium term, while ensuring the defensive characteristics are not compromised.
Since inception, the fund has produced an annualised return after fees of 6.79% p.a., compared to the UBS Composite Bond index return of 6.45% p.a. over the same time period. Generally the fund will distribute income on a quarterly basis. However, this can vary depending on market conditions in any given period.
The following table illustrates the performance of the fund to June 2013 after fees:
The fund currently holds 653 securities with an average credit rating of A. While over 56% of the portfolio is comprised of Australian bonds, no Government bonds are currently held. Instead the manager has preferred semi-Government bonds such as Queensland Treasury Corp and Treasury Corp of Victoria – both state Government funding authorities. These have been preferred, as they provide higher yields with little additional credit risk.
The manager has, for some time now, held a significant portion of the fund assets in cash and cash equivalents. This reflects the manager’s concern in regards to the valuations of fixed interest assets and the potential impact of higher interest rates. Cash & cash equivalents currently comprises over 32% of the portfolio assets.
Although this can lead to lower income returns in the short term, this strategy effectively lowers impact on the portfolio of higher interest rates. While it is true that official Australian interest rates are likely to be further reduced in the short term, long term rates have in fact been rising in the past months. This is a result of the recent indication by the U.S. central bank that monetary accommodation strategies were likely to be curtailed in the medium term. Thus the perception in global bond markets is that the long term interest rate easing cycle is coming to an end. This has prompted heavy selling of bonds, and has pushed yields up across global markets. As cash and short term fixed interest assets are less impacted by rising rates, the strategy of the manager has succeeded in its prime objective of preserving capital.
We believe this active approach to managing the portfolio, and the willingness of the manager to take a view contrary to market consensus helps to deliver capital stability, as well as an acceptable level of income over the medium term. By including this fund in your portfolio, we are able to achieve a higher level of confidence that the defensive part of your portfolio remains true to label.
The fund provides an anchor point in your portfolio that allows us to pursue additional strategies with other managers to enhance the level of income provided by this sector. Apart from your allocation to cash, your investment in this fund is designed to be, essentially, boring.
For further information regarding this or any other investment, please contact our office.