“They offered high yields relative to their credit quality, and were less interest rate sensitive than US and European bonds because of their much shorter average duration,” the Perth-based manager of the Aberdeen Standard SICAV Australian Dollar Income Bond Fund told FSA in a phone interview.
Since then, Australian government bond yields have fallen, with yields on the benchmark 10-year notes dropping to 1.4% from as high as 2.91% in (March) 2017. The Reserve Bank of Australia (RBA) has cut interest rates once already this year to 1.25%, and more cuts are expected.
“Yet, Aussie bonds still offer incremental yield for their credit quality,” insisted Innes.
The fund’s average yield-to-maturity is about 4%, and has a current yield of 4.4%, according to the fund’s factsheet. It pays out every month, and its 12-months average distribution yield is between 3.5% and 4%, added Innes.
The fund was launched to Singapore private banks and wholesale distributors in June 2017 and ASI introduced a AUD240m ($164m) version of the fund in the Taiwan onshore market on 27 May.
“We can allocate up to 30% assets in high yield bonds and we have gone up to that threshold in order to maintain a competitive yield level,” Innes said.
Aussie vs Asia bond yields
Corporate fixed income lagged during an investor flight to quality in a period of domestic economic slowdown and political turbulence. Hence, the yield spread difference between BBB investment grade corporate issues and government bonds has widened to 300 basis points currently from 240bp a year ago, according to Bloomberg data.
The spread is wider than the average available from Asia investment grade bonds, which narrowed to 130bp this month. However, an Asia bond portfolio that also has a significant weighting to sub -investment grades can enhance its overall yield to close to 4%. For instance, the average yield-to-maturity of the iShares JP Morgan USD Asia Credit Bond Index ETF, managed by Blackrock, is 3.96%, according to the firm’s website.
“However, it’s like comparing apples with oranges,” said Innes.
“Australia is a highly-developed democracy with strong economic fundamentals, and the news in the last few months has been good for the whole of the fixed income market,” said Innes.
“The conservative coalition’s victory in the recent election quelled fears about the opposition Labor Party’s plans for restricting gearing in the property market, while the RBA’s interest rate stance has further helped to restore confidence,” he said.
Moreover, the Australian corporate bond market now offers more diversification than a decade ago and is increasingly dominated by foreign borrowers, especially overseas banks, he said.
“The fund has a 47.5% weighting to the financial sector, and we have found great opportunities to buy Australian dollar-denominated issues from quality overseas banks,” said Innes.
The portfolio includes Lloyds, Deutsche, Societe Generale and Credit Agricole. In fact, its holdings in the two French banks make up almost 10% of the fund’s NAV, according to the factsheet.
One risk, however, is if the manager has to go down the credit curve to maintain a competitive yield.
Additionally, a problem for foreign investors with the US dollar as their base currency is foreign exchange risk. The Australian dollar has been volatile since the fund’s launch, and has declined 15% from its two-year peak in January 2018.
The fund’s annualised volatility in local currency terms is only 1.69% since inception, but in a US dollar terms it is a whopping 7.69%.
|Cumulative return since launch (1/6/17)|
|Weighted average life|
|Average credit rating|
|Size of fund|
|Number of holdings|
Source: Fund Factsheet, FE Analytics
*returns and volatility in US dollars (17 June 2019)
Aberdeen Standard SICAV Australian Dollar Income Bond Fund