Chris Joye, founder & CIO of Coolabah Capital shares what he considers the big issue for those investing in Fixed Interest
Fixed Interest investors could chase value, not yield
Chris Joye believes investors face an existential challenge in cash and defensive asset classes as deposit rates have converged towards zero. Longer-term interest rates/yields are near all-time lows. As discount rates plummet, the valuations of all investments are being stretched to extreme levels.
This situation is unlikely to change any time soon. So, how do investors get decent returns above and beyond the current rate of inflation – expected to be around 1% to 2% annually? In the bond market there are essentially two choices: add-value or add-risk. Adding value is very difficult. By way of contrast, adding risk is easy.
Investors can chase higher yields by taking on three different forms of bond market risk (or beta). The most obvious is by investing in bonds/loans with higher risks of default and loss.
Virgin’s senior unsecured bonds listed last year were a classic example. They offered a stunning 8% yield for a senior unsecured loan from a well-known brand, but Virgin was unprofitable and highly leveraged. Today the bonds are worthless.
Another option is chasing higher yields by investing in loans facing illiquidity, such as illiquid corporate bonds, and subordinated Australian RMBS/ABS (Residential Mortgage Backed Securities/Asset Backed Securities). A third alternative for higher yields is through investing in long-term fixed-rate bonds offering superior interest rates, compensating for the risk of loss if rates rise and the value of these bonds decline.
The harder road is adding value (or alpha). This is what Coolabah does using a large team of 5 portfolio managers, 13 analysts and more than 30 sophisticated models which allow us to find mispriced bonds that offer capital gains (or price appreciation), not higher yields.
It means constantly revaluing thousands of bonds and actively buying and selling securities that are cheap and liquid, and which are expected to normalise back to fair-value.
In the current environment we believe this is a crucial consideration for investors – it’s about offering the prospect of safer capital gains (alpha) rendered through genuine skill, not luck.
Coolabah Capital Investments (CCI) is a Sydney based fixed interest manager, established in 2011. Coolabah are different to many other fixed interest managers in that they seek to acquire cheap, mispriced bonds paying excess interest (credit spread) for their risk factors. As credit spreads normalise/mean-revert, CCI generates capital gains on top of interest paid on the bond. These capital gains become increasingly important in a low-yielding environment and are driven by credit alpha. They have one of the largest fixed interest rate teams in Australia with 5 portfolio managers, 13 analysts, and 26 staff in total. They now have in excess of AUD6.3bn funds under management and over AUD9bn of assets under management.