The above chart shows the 6 month daily correlation between Hedged Global Shares and four Australian bond funds…
- Tyndall Australian Bond
- UBS International Bond
- Macquarie Diversified Fixed Interest
- Principal Global Strategic Income Fund
Each fund is different. Tyndall is invested in high grade Australian bonds, UBS International in high grade global bonds, Macquarie is 60% Australian bonds, 40% global and also takes on some investment grade credit risks, and Principal’s fund invests in high yielding securities including hybrids, asset backed securities, junk bonds, as well as some conservative bonds. All global exposures are hedged to Australian dollars.
What this chart demonstrates is the increasing correlation between Principal and hedged international shares from mid 2007, the start of the credit crunch. Basically, diversification benefits did not really exist for the high yielding investment.
However for the other funds, which had conservative bonds as a high proportion, their low correlation with hedge international shares shows their diverisifcation benefits in tact.
So a simple conclusion is…whilst high yielding investment may giove you the opportunity for higher returns, don’t think they will provide diversification benefits if sharemarkets tank. With a weak outlook for shares, so too is the outlook for companies to pay their debt so the price of low-grade credit can fall significantly also. A final point, which is often overlooked…bonds have limited upside…at maturity the most you will ever receive is the face value…that’s it.
The above table shows the returns for various subclasses of fixed interest from the perspective of the Australian investor (i.e. in Austrlaian dollars) through to the end of June 2009. As can be seen, the World Government Bond index hedged to Australian dollars has been the winner over the last 3 and 5 years. High Yield, as expected given the widening of credit spreads over the last 2 years, comes in last.
Disappointingly, the Morningstar index of bond fund managers fall quite short versus their respecitve indices. For example, Morningstar Australian Bond managers perform significanlty worse than the UBS Composite index and the Morningstar Global Bond managers perform well below the BarCap Global Aggregate index.
As the above chart shows, the Australian government yield curve has been steepening ever since the end of last year. This yield curve is a good indicator of the future strength of the AUstralian economy. As it shows, during June of 2008 the curve was negative (i.e. sloping downwards) and worst case scenario, is that a negative yield curve signals potential recession as there is no premium for long term rates like you would expect. Right now, 5 August, the curve is incredible steep with current interest rates at 3% and 5 year government bonds yielding around 5.5%. This curve indicates there is only one direction for rates to go and that is up…and that is only likely to occur if the economy is strong.
There is no doubt the outlook for the Australian economy and global economy) has improved in recent months, but the speed of the improvement, whether sharemarkets or the strengthening of the above yield curve, has been startling. Whilst yields aren’t what they used to be, has this rapid improvement been to fast, so is there a short term opportunity for bonds? If not, then can this yield curve get steeper?
My latest IFA educational article can be found here.
Recently I met with a fund manager who was showing me how his direct property fund had lower volatility than the listed property index. Given the infrequency of direct property valuation, volatility measures, like standard deviation, should probably be ignored.
My latest article published in IFA magazine simply shows how volatility can be manipulated and mis-used…just like my friendly direct property fund manager.
An article I wrote earlier in the year for IFA magazine can now be found here. Basically the article shows how it is possible to outperform and index but display no skill (or alpha); and vice versa…i.e. underperform an index and show skill (or alpha).
Following the APRA report from a few weeks ago, late last week Standard and Poors published a paper that wasn’t too flattering of the active side of the Australian funds management industry. The paper can be found here.
Their analysis had the following conclusions:
- Over 5 years, the benchmarks outperformed the majority of active managers
- ASX/S&P200 index outperformed two-thirds of active Australian general equity funds
- UBS Composite 0+ Bond index outperformed more than 97% of actively managed bond funds over the last 5 years
- Between 10% to 30% of all funds have disappeared over the last 5 years
A fascinating, but unsurprising result of which most in fund research or academia have known for a long time. The most surprising result is that it has come from Standard and Poors who are potentially damaging their own business (albeit in a very small way) by suggesting that active management, on average, fails.
I guess Standard and Poors will be suggesting that it requires their skill to pick the best managers!!!
