MACQUARIE PRIVATE PORTFOLIO MANAGEMENT · PDF fileMacquarie Private Portfolio Management . 1....

MACQUARIE PRIVATE PORTFOLIO MANAGEMENT

sallen8

Typewritten Text

DIVERSIFIED FIXED INTEREST STRATEGY DISCUSSION

Macquarie Private Portfolio Management 1

Macquarie Private Portfolio Management Limited

Diversified Fixed Interest Strategy Discussion Paper

January 2013

Executive Summary

Purpose

The purpose of this discussion document is to summarise MPPM’s Diversified Fixed Interest strategy’s

characteristics, performance, recent drivers of the Australian bond market and trends in the listed interest

rate securities market.

Background

MPPM has been operating discretionary investment portfolios focused on fixed interest and listed interest

rate securities (IRS) since its inception in 2000. We offer clients a blended exposure to fixed interest with

IRS, high credit quality fixed rate bond exposure via managed funds (mainly Government debt) and cash,

to provide clients with a holistic income producing exposure.

Fixed interest and the IRS universe have been attracting increased investor interest during recent months

as a result of:

• the positive returns achieved over short and long term time horizons from this sub-sector,

• the large amount of new issuance in the listed IRS universe during the last twelve months (~$12bn

in 2012),

• relative capital stability compared to equity markets, and

• high tax effective yields available in a falling cash rate environment.

• We expand on these points in the following pages.

As a result of these developments we have seen renewed interest in this asset class from both investors

with a high allocation to growth assets, looking to reduce volatility in their long term investment portfolios

and also investors looking to reallocate a portion of their cash investment to enhance returns (exploring

options to earn a higher yield, following the recent Reserve Bank of Australia ‘RBA’ cash rate reductions).

The following paper provides details and insights into our Diversified Fixed Interest Strategy, recent events

in the Australian bond market and IRS universe, and briefly describes our investment process.


Table of Contents

MPPM DIVERISIFIED FIXED INTEREST STRATEGY ................................................................ 3

Strategy Overview .................................................................................................................................................. 3

Objective ................................................................................................................................................................ 3

General Portfolio Characteristics............................................................................................................................ 3

Current Portfolio Characteristics ............................................................................................................................ 4

Strategy Returns .................................................................................................................................................... 4

AUSTRALIAN BOND MARKET ................................................................................................... 5

Why bond market exposure ................................................................................................................................... 5

Current characteristics of the Australian bond market ............................................................................................ 5

Recent performance of the Australian bond market ............................................................................................... 5

Movements in Australian government bond yields ................................................................................................. 6

Australian Fixed Interest fund exposure ................................................................................................................. 7

LISTED INTEREST RATE SECURITIES ..................................................................................... 7

Why listed interest rate securities ........................................................................................................................... 7

What is the listed interest rate securities market .................................................................................................... 8

Listed Interest Rate Securities vs. Equities ............................................................................................................ 9

Drivers of Recent Issuance .................................................................................................................................. 10

Universe Concentration ....................................................................................................................................... 11

Liquidity ............................................................................................................................................................... 12

Current Valuation ................................................................................................................................................. 13

MPPM’S INVESTMENT APPROACH ........................................................................................ 14

MPPM’s Investment Approach ............................................................................................................................ 14

Risk Management ............................................................................................................................................... 15

Recent Strategy Performance & Volatility Charts ................................................................................................ 16

SUMMARY…………………………………………………………………………………….…….…. 17


MPPM DIVERSIFIED FIXED INTEREST STRATEGY

Strategy Overview

MPPM’s Diversified Fixed Interest strategy blends exposure of:

• High quality listed interest rate securities,

• Domestic unlisted fixed rate bond markets, and

• Cash.

We actively manage a portfolio of directly held listed interest rate securities and wholesale domestic fixed

interest managed funds. For full strategy details please refer to the detailed MPPM Diversified Fixed

Interest strategy description document available on the resources page of our website.

Objective

The strategy has two key objectives:

• Primary Objective – to provide a tax effective yield at a premium to the cash rate with moderate

levels of capital volatility, via investment predominantly in ASX listed interest rate securities,

diversified fixed interest exposure and cash.

• Secondary Objective: to outperform the UBS Australian Composite Bond Accumulation index by

one per cent after fees and costs, in a tax efficient manner, over three to five years.

Expected Return Outcome The portfolio is expected to provide the following return outcomes:

• Provide a reliable tax effective yield, at a premium to cash rates,

• Portfolio has higher potential volatility than pure bond market exposure,

• As a mainly credit focussed strategy the portfolio:

- is expected to perform well during times of benign and improving credit markets,

- will perform below long run expectations during periods of credit market instability,

- diversification helps smooth overall portfolio volatility,

• Portfolio turnover is expected to be moderate (15 to 25 per cent) per annum.

General portfolio characteristics MPPM select investments on an after taxation basis and runs a number of variations of the strategy for

clients with different taxation status. Most clients are seeking a strategy which benefits from imputation

credits and this is a focus of this paper. The following table shows the characteristics of the portfolio as at

January 2013:


Table 1: Current Portfolio Characteristics

Portfolio sub-sector exposure With ImputationAustralian Bond Market Exposure 29.0%Cash 3.1%Listed Interest Rate Securities 67.9%Portfolio 100.0%

Portfolio Characteristics With ImputationExpected Gross Internal Rate of Return 5.75%Current Gross Running Yield 5.81%Average Issuer Credit Quality AA to AA-Minimum Issuer Credit Quality BBB-Modified Duration (years) 1.25Fixed Rate exposure 29.0%

Australian bond market exposure characteristics With ImputationAssumed Yield to Maturity (Long Term Assumption) 5.5%Modified Duration (years) 3.8Number of funds held (Macquarie Enhanced Australian Fixed Interest fund) 100.0%Number of securities within index 250+Average underlying index constituents credit quality AAA to AA+Fixed Rate exposure 100.0%

Listed Interest Rate Securities (IRS) characteristics With ImputationExpected Gross Internal Rate of Return 5.98%Current Gross Running Yield 6.08%Trading margin above swap rates 3.04%Number of listed IRS held 14% of listed IRS exposure paying franked distributions 58.8%Fixed Rate exposure 0.0%

Source: MPPM, Feb 2013

Strategy Returns

The following table shows the Diversified Fixed Interest Strategy recent and longer term returns1, including

imputation credits.

Table 2: Diversified Fixed Interest Strategy Returns

Source: MPPM, Iress. Jan 2013

N=Returns shown are prior to MPPM Management fees. The gross return shows the assumed after taxation return for a 0% taxpayer entitled to rebate imputation credits. Past performance is not indicative of future performance=


AUSTRALIAN BOND MARKET

Why bond market exposure?

MPPM believes that in the longer term, a diversified approach to portfolio construction is likely to result in

lower portfolio volatility and greater likelihood of meeting the strategy’s return objective. Within the

Diversified Fixed Interest Strategy, MPPM currently invests in the Macquarie Wholesale Enhanced

Australian Fixed Interest Fund to provide clients with exposure to Australian bond markets. This fund is

managed by Macquarie Investment Management Limited (MIML) – a separate entity to Macquarie Private

Portfolio Management. Specifically the following are the key benefits of exposure to the Australian bond

market:

• High credit quality, fixed rate exposure to Australian unlisted bonds (mainly Australian Government

debt), • Quarterly income stream, • Potential for positive returns in the event that the domestic and global economic outlook

deteriorates, • Materially increases overall portfolio diversification benefits and credit quality, and • Performs well in a falling interest rate environment.

Current characteristics of the Australian Bond market

The following table charts highlights the key characteristics of the UBS Composite All Maturities Bond

Index, referred to as ‘the Australian bond market’ for the purposes of this discussion.

Source: MIML, MPPM, Jan 2013 Recent performance of the Australian Bond Market

The performance of the Australian bond market has been above average over the last12 months and the

five years since 2007. Strong returns have been driven by: a moderation in the outlook for domestic

growth, reductions in the domestic cash rate to 3%2, a global flight to safety (increased risk aversion) and

significant buying of domestic government bonds from offshore investors. These four drivers have resulted

in bond yields falling (driving capital prices of bonds higher). Table 3: Australian Bond Market and the

Macquarie Enhanced Australian FI fund returns

O=pçìêÅÉW=o_^=EoÉëÉêîÉ=_~åâ=çÑ=^ìëíê~äá~I=g~å=OMNPF=


Source: MPPM, MIML, Iress. Jan 2013

Movements in Australian Government Bond Yields During 2012, Australian bond markets rallied materially, mainly in the June quarter 2012 due to increased

risk aversion, increased buying of domestic bonds by offshore participants and action by the RBA to lower

the domestic cash rate. This is illustrated in the following chart which shows that during financial year 2012

the yield on the Australian 10 year government bond fell from 3.7% to 3.3%, and during the June quarter

yields hit an all time low of 2.7%.

Chart 1: Australian Government Bond Yields (2012 year)

Australian Commonwealth Government 10 Year Bond Rate - 2012

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

4.00%

4.50%

5.00%

2/01

/201

2

16/0

1/20

12

30/0

1/20

12

13/0

2/20

12

27/0

2/20

12

12/0

3/20

12

26/0

3/20

12

9/04

/201

2

23/0

4/20

12

7/05

/201

2

21/0

5/20

12

4/06

/201

2

18/0

6/20

12

2/07

/201

2

16/0

7/20

12

30/0

7/20

12

13/0

8/20

12

27/0

8/20

12

10/0

9/20

12

24/0

9/20

12

8/10

/201

2

22/1

0/20

12

5/11

/201

2

19/1

1/20

12

3/12

/201

2

17/1

2/20

12

31/1

2/20

12

Source: MPPM, Iress. Jan 2013

Given the current valuation of domestic bonds, we expect more muted returns from bond markets in the

near future, although remain attracted to their potential to deliver positive returns should the global

macroeconomic outlook deteriorate.


Australian Fixed Interest fund exposure

The MPPM Diversified Fixed Interest Strategy currently gains exposure to bond markets through the

Macquarie Enhanced Australian Fixed Interest fund. This wholesale fund (managed by MIML) has the

following characteristics:

• Low tracking error approach to portfolio construction, with the Fund Manager looking to add

value via security selection, sector rotation and yield curve positioning,

• The strong historical track record relative to the bond index, and also comparable managers.

• A physical portfolio of fixed interest securities is held,

• The portfolio only invests in securities issued by investment grade borrowers and cash,

• All derivative exposure is fully cash backed (bond futures are often used for interest rate risk

management),

• A very competitive Management Expense Ratio (0.19%), and MPPM clients are currently

eligible for a partial rebate of this fee (as at January 2013).

The key portfolio characteristics of the fund as at 31st December are as follows:

Source: MIML, MPPM, Jan 2013

LISTED INTEREST RATE SECURITIES

Why listed interest rate securities? MPPM currently blends its bond market exposure with a range of directly held listed interest rate securities

(IRS) that undergo our rigorous portfolio construction requirements. Following are the key

benefits/characteristics of the Australian listed IRS market:

• IRS pay a regular, tax efficient income stream (generally floating rate) at a premium to cash and

bond market interest rates,

• We access a wide range of structures with two common characteristics being:

- higher in the capital structure than equity,

- a fixed face value (generally $100 per security),

• MPPM focuses on providing high quality, low beta exposure to this sub-sector,


• Exposure to Australian credit markets, which MPPM believes are currently undervalued when

compared with long term valuations,

• Are expected to perform well during times of benign and improving credit markets,

• Are likely to underperform (relative to Government bonds) during periods of credit market

instability, and

• Are likely to perform well in a rising rate environment (unlike fixed rate bonds).

The Listed Interest Rate Securities market? The listed interest rate securities market is a broad collection of income producing investments in a range

of fixed interest (or fixed interest like) structures. It has a current market capitalisation of approximately

$34.2bn across 74 separate issues3. As shown in Chart 2, the IRS market has grown steadily in recent

years. The predominant issuers have been large, domestic companies with investment grade credit ratings.

Investment Grade means the issuer has an independent credit rating from Standards and Poor’s, Moody’s

or Fitch Ratings that is, above the cut off point for the general definition of Investment Grade. The

minimum Investment Grade credit rating is BBB- for S&P or Baa3 from Moody’s.

Securities issued are typically subordinated debt securities or preference equity (they no longer have

independent security level credit ratings in the retail/listed market due to regulatory changes in 2010).

Chart 2: Historical Market Capitalisation

Historical Market Capitalisation : ASX listed interest rate securities

$0

$5,000,000,000

$10,000,000,000

$15,000,000,000

$20,000,000,000

$25,000,000,000

$30,000,000,000

Mar

-01

May

-01

Jul-0

1

Sep-0

1

Nov-0

1

Jan-

02

Mar

-02

May

-02

Jul-0

2

Sep-0

2

Nov-0

2

Jan-

03

Mar

-03

May

-03

Jul-0

3

Sep-0

3

Nov-0

3

Jan-

04

Mar

-04

May

-04

Jul-0

4

Sep-0

4

Nov-0

4

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep-0

5

Nov-0

5

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep-0

6

Nov-0

6

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep-0

7

Nov-0

7

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep-0

8

Nov-0

8

Jan-

09

Mar

-09

May

-09

Jul-0

9

Sep-0

9

Nov-0

9

Jan-

10

Mar

-10

May

-10

Jul-1

0

Sep-1

0

Nov-1

0

Jan-

11

Mar

-11

May

-11

Jul-1

1

Sep-1

1

Nov-1

1

Jan-

12

Mar

-12

May

-12

Floating Rate Notes

Corporate Bonds

Convertible Notes

Hybrids

Source: ASX, MPPM, June 2012

In general, the IRS market provides floating rate credit exposure to investors. Investors benefit from relative capital stability, historically high credit margins, tax effective regular income streams and priority to ordinary equity.

P=Source: ASX Dec 2012 Listed Interest Rate Securities market update=


The key structures include:

• Senior Bonds,

• Subordinated Debt,

• Subordinated Floating Rate Notes, Preference Securities and Capital Notes (often referred to as

‘Hybrids’, however they generally have no embedded equity price risk).

Within these classifications there is a large variety of security characteristics and terms that make each

issue unique.

Key security characteristics include: regular income stream, priority to ordinary equity, issued by investment

grade ASX 200 companies, fixed face value of $100 per security (potential to convert to equity or redeem

at face value), 5-7 years expected time to redemption4.

The key risks can be summarised as: credit and market risk, credit spread duration (short term impacts

from movements in credit spreads), bank bill swap rate risk (re-investment risk), maturity extension risk

(many securities are perpetual securities) and specific terms of issue.

Listed Interest Rate Securities versus Equities

A key benefit of a listed interest rate security is its priority ranking within the issuer’s capital structure. In

the event that companies issue further equity, listed interest rate securities remain in priority rather than

being diluted as equities would be. The following table outlines the relative ranking of a company’s capital

structure. As noted, the IRS component of client portfolios MPPM invest includes Senior Bonds,

Subordinated Bonds, Subordinated Notes and Preferred Equity.

Table 4: Capital Structure

The income stream of IRS is more reliable as it is set by the terms of issue, rather than management

discretion and is paid in priority to ordinary equity. Most issues have capital restriction clauses which limit

the issuer’s ability to pay equity dividends or return capital to equity holders unless listed IRS distributions

are paid first. Many securities have cumulative interest payments, whilst bank Convertible Preference

Q= In many structures redemption at the first call date is not certain, and subject to management discretion or minimum share price requirements in certain circumstancesK=


Shares ‘CPS’ securities distributions are non-cumulative they are paid in priority to equity dividends and

have a set level of required catch up of IRS distributions before equity distributions can resume.

Many of the newer structures in particular have maturity dates and material incentives to redeem at the first

call date (generally five years). Some of the converting preference shares may be perpetual in nature,

however, are likely to redeem earlier unless the issuer suffers financial distress. This is due to the

mandatory conversion clauses, potential loss of APRA capital benefits and reputational risks for the

issuers.

Another key difference between equities and fixed interest is the asymmetric risk profile. Listed interest rate

securities have a fixed face value (generally $100 per security) and over time converge to their face value

as maturity/redemption approaches. This fixed face value also leads to greater capital stability, when

compared to equities. However, listed IRS (and other debt securities) can generally be worth no more than

their face value, but can be worth materially less in the event that the issuer defaults. To mitigate the

potential for default, MPPM only invests in the higher quality issuers and structures and undertakes a

detailed research process at both the issuer and security level.

Drivers of Recent Issuance Since November 2011, approximately $19bn has been raised by Australian companies5. These issues

have been dominated by Industrial Companies and Banks/Insurance companies.

Key drivers of the increased issuance have been the elevated cost of funding in wholesale markets and

strong investor demand for high yielding securities. Other drivers of issuance have been changes to credit

rating agencies rating methodologies, the resulting impact on structures and the upcoming introduction of

Basel III.

Industrial companies have sourced funds from the market by issuing ‘subordinated notes’ which meet the

credit rating agency requirements for ‘equity classification’, for a period of time. Generally at the end of

year five, the rating agency classification of the security moves from equity to debt, acting as an incentive

for the issuer to redeem or replace the security. Recent issuers to take advantage of this structure include:

Woolworths, Origin Energy, Colonial Group, Tabcorp, and AGL Energy. Smaller, unlisted or unrated

companies have also used senior bond structures to access funding from the market (in light of higher

wholesale funding costs). These include Tatts Group and Heritage Bank.

During 2012, banks and insurance companies issued two Basel III compliant structures. Westpac and

Insurance Australia Group ‘IAG’ issued CPS structures that meet the new requirements for Tier 1 Capital6.

These Basel III compliant mandatory converting preference securities have important structural differences

to the previous structure of bank converting preference securities, due mainly to a contingent capital

clause. ANZ Banking Corporation, Westpac Bank and National Australia Bank ‘NAB’ issued high quality

subordinated bond securities meeting the Basel III Tier 2 capital requirement. The attractive terms resulted

in strong investor demand and both issuers were able to raise more than $1bn from listed investors with

pricing similar to the current wholesale market (above 275bps).

5 Source: MPPM, Iress, ASX Jan 2013 Market Update=S=Tier 1& 2 capital are forms of capital banks are required to hold under APRA and BASEL regulations. T1 is generally more flexible capital than T2.


MPPM has taken advantage of the large amount of new issuance as it provides our portfolios with strong

diversification benefits. We have invested in a number of the new securities but have rejected a number of

securities as they did not meet our quality filter. Access to deals at IPO means trading occurs off-market

and does not incur additional brokerage.

For full details of each specific issue please refer to the individual PDS. Table 5: Summary Characteristics of Recent Issues

IssuerSecurity

CodeStructure Margin

Amount Raised

($m)

Expected Term to redemption

/exchange

Final Maturity

Woolworths Limited WOWHC Subordinated Note - dated, unsecured, subordinated, cumulative note 325bps 700 5 years 25 years

Origin Limited ORGHA Subordinated Note - dated, unsecured, subordinated, cumulative note 400bps 900 5 years 60 years

Tabcorb Limited TAHHB Subordinated Note - dated, unsecured, subordinated, cumulative note 400bps 250 5 years 25 years

Colonial Group CNGHA Subordinated Note - dated, unsecured, subordinated, cumulative note 325bps 1,000 5 years 25 years

AGL Energy AGKHA Subordinated Note - dated, unsecured, subordinated, cumulative note 380bps 650 7 years 27 years

Tatts Group TTSHA Senior Bond 310bps 200 7 years 7 years

Heritige Bank HBSHB Senior Bond 310bps 227 5 years 5 years

Westpac Bank WBCPC Mandatory Converting Preference Share 325bps Gross 1,168 8 years Perpetual

Insurance Australia Group IAGPC Mandatory Converting Preference Share 400bps Gross 377 7 years Perpetual

ANZ Bank ANZHA Subordinated Debt 275bp 1,509 5.25 years 10.25 years

National Australia Bank NABHB Subordinated Debt 275bp 1,172 5 years 10 years Source: MPPM, Issue PDS, S&P Global Credit Portal July 2012.

Universe Concentration The market capitalisation of the sector is approximately $34bn across 74 individual securities7. When

excluding smaller and lower quality securities from the universe: approximately 50 securities are of

sufficient size and quality for MPPM to consider for portfolio inclusion. At the issuer level, we consider the

universe to be concentrated (as noted in Chart 3 & 4). The following two charts illustrate the composition of

the universe.

Chart 3: IRS Market Capitalisation of Major Banks

ASX Listed IRS Market Capitalisation - Major banks (~60% of universe)

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

ANZ Bank CBA Westpac NAB

Source: Iress, MPPM July 2012.

Chart 4: IRS Market Capitalisations – Ex Top 4 Banks

T=Source: MPPM, Iress, ASX Jan 2013 Market Update=


ASX Listed IRS Market Capitalisation - Non Big 4 bank (~40% of universe)

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

4.00%

Sunc

orp

Colon

ial G

roup

Insu

ranc

e Au

stralia

Group

Orig

in E

nergy

Woo

lworths

AGL En

ergy

Mac

quarie G

roup

Tabc

orp Group

Seve

n Med

ia

Multip

lex

Bend

igo Ba

nk

Mac

quarie B

ank

Goo

dman

Group

Pape

rlinx

Australand

Ram

say Hea

lthca

re

Nufarm

Tran

spac

ific Indu

strie

s

Australia

n Fo

unda

tion

AMP

Bank

of Q

ueen

slan

d

Prim

ary Hea

lthca

re

Elde

rs

Hea

lthsc

ope Ltd

ALE

Prop

erty

Australia

n Unity

Gun

ns

Broo

kfield

Peet &

Co.

Source: Iress, MPPM July 2012.

Like the Australian wholesale corporate debt market, the majority of issuance comes from high credit

quality banks and other financial issuers.

Key details of the universe include:

• 50 securities across 33 different issuers,

• 95.5% of the universe is floating rate, major domestic banks dominate the universe, with the four

major Australian banks comprising 60% by market capitalisation (ANZ 20.5%, CBA 18.5%, WBC

12.9%, and NAB with 8.7%) or 42% by the number of securities (14),

• The next 29 issuers account for 40% of the sector.

We consider the universe large enough to provide suitable diversification across each individual issuer

however; we acknowledge the portfolio is skewed to major domestic banks. At the portfolio level we

currently have a 10% maximum issuer exposure rule, but generally hold a position size of 4%-7%. This

results in a portfolio holding 10-15 individual securities from a range of issuers, as well as a diversified

bond fund exposure via the Macquarie Enhanced Index Fixed Interest Fund.

Liquidity Given the purpose of the investment is to source a regular income stream, investors in IRS often take a buy

and hold approach to investing. As a result, annualised turnover is moderate at approximately 20% per

annum8 (around 1/5 of the ASX 200 equity market which generally has turnover of greater than 100% per

annum). At times of market crisis or where credit concerns regarding a specific issuer arise, liquidity can

tighten and result in volatile price behaviour.

MPPM manages liquidity in a number of ways, including; blending investments between the bond fund,

cash and listed IRS, setting issuer risk limits, security and tenure diversification, high quality focus (issuer,

size and terms of issue) and taking a medium to long term investment horizon. Additionally, we deal with a

variety of institutional brokers who have dedicated dealing desks that focus on the IRS universe. We

U=Source: ASX May 2012 listed IRS market update.


typically use off–market transactions such as IPO’s, buybacks and redemptions as our key source of

liquidity.

Current Valuation We currently consider the valuation of IRS to be attractive due to high credit margins available for

investors. Grossed up income streams are almost double the current cash rate (before management fees).

Individual security returns range from 200bps to 600+bps depending on both the issuer, structure and

security specific terms of issue, with an average of approximately 325 basis points (as at Dec 2012) based

on our modelling of the sector. Securities with more flexible terms of issue, uncertainty regarding near term

redemption events, long times to maturity or lower credit quality generally trade at higher margins.

Trading margins available for investment increased during 2012, as a result of an increase in risk premiums

and technical factors, such as new issuance in the market, however over the last few months the risk

premiums/margins have been reducing, driving capital values of securities higher. The following chart

shows the movement in the Australian Corporate Itraxx Index since January 2010. This chart highlights

credit spreads are currently elevated and that a material premium exists in the listed IRS market relative to

senior debt. We expect credit margins to remain elevated and somewhat volatile in the medium term.

(Note: Prior to 2007 average margins from the listed universe was ~1% with investors not pricing more

flexible structures as widely as they do now).

Investors buying into the portfolio can now lock in the 3% margin above the bank bill swap rate for the

medium term (3-5 years).

Chart 5: Corporate Itraxx Bond Index

Australian Domestic Itraxx Index (Corporate Credit Spreads): Jan 2010 - Dec 2012

0

50

100

150

200

250

300

350

1/01

/201

0

1/02

/201

0

1/03

/201

0

1/04

/201

0

1/05

/201

0

1/06

/201

0

1/07

/201

0

1/08

/201

0

1/09

/201

0

1/10

/201

0

1/11

/201

0

1/12

/201

0

1/01

/201

1

1/02

/201

1

1/03

/201

1

1/04

/201

1

1/05

/201

1

1/06

/201

1

1/07

/201

1

1/08

/201

1

1/09

/201

1

1/10

/201

1

1/11

/201

1

1/12

/201

1

1/01

/201

2

1/02

/201

2

1/03

/201

2

1/04

/201

2

1/05

/201

2

1/06

/201

2

1/07

/201

2

1/08

/201

2

1/09

/201

2

1/10

/201

2

1/11

/201

2

1/12

/201

2

1/01

/201

3

Date

Bas

is P

oin

ts (10

0 = 1

.00%

)

Average Listed IRS Gross Credit Margin, Jan 2013

Source: Iress, MPPM, Bloomberg, Jan 2013.


The other key driver of valuations is the movement in the bank bill swap rate (BBSR), as 95% of the

universe has a floating rate income stream. The BBSR is currently 2.95% (as at Jan 2013) effectively

pricing in a chance of another Reserve Bank of Australia (RBA) rate cut in the near term. Given the current

outlook for the domestic economy and the fact the RBA has already cut the domestic cash rate to 3.0%

(from 4.25% in April 2012) we expect the BBSR to stabilise around current levels, although may go slightly

lower later in the year ahead if the RBA lowers interest rates further. A material deterioration of European

sovereign debt outlook or China as our major trading partner could see the RBA cutting rates beyond our

base case (which is that only moderate further rate cuts are likely in the near term).

We consider the listed interest rate security universe currently offers an attractive income stream due to

high margins and tax effective imputation stream. The income stream and expected internal rate of return

available is almost 100% higher than the current cash rate (the portfolios current IRR is approximately

5.8% vs. the current cash rate at 3.0%) and lower than risk government bonds, this represents an

appropriate premium for structural subordination.

MPPM’s INVESTMENT PROCESS

1. MPPM’s Investment Approach

MPPM has a thorough investment process with more than ten years experience constructing Fixed Interest

mandates. We draw upon internal proprietary research as shown above that is supplemented and tested

against third party fixed interest, credit rating and listed IRS specific research (which is sourced through our

external broking arrangements).

Fixed Interest Funds - MPPM review fixed interest funds prior to investment, with focus on track record,

quality of underlying exposure, tracking error, risk, liquidity, style and fees.

The portfolio weighting to fixed interest funds depends upon MPPM’s outlook for domestic interest rates,

yield curve, risk environment and the relative opportunities available in listed interest rate securities and the


various categories of unlisted wholesale debt including Commonwealth Government Bonds, Semi

Government Bonds, Corporate Bonds/FRN’s and asset backed instruments. Additionally, all underlying

exposure within any selected fund must have an independent credit rating that meets the traditional

definition of “Investment Grade” and geared funds are excluded from investment.

Our research and investment process within the listed universe can be best described as “quality at a

reasonable ‘after taxation’ value”. We have a strong focus on quality at the issuer level (in terms of credit

quality and equity outlook) and specific focus on quality at the structure level, which is particularly important

given the diverse terms available at the security level. We undertake credit and equity research on the

securities prior to investment to determine our own internal ‘shadow’ credit ratings. In addition to issuer

research the terms of issue must meet our requirements with regards to fixed interest characteristics and

solid risk and return characteristics. In summary we focus on: Is it a good issuer? Is it a good structure?

Does it offer value on a risk adjusted basis?

Our portfolio construction approach screens out issuers who don’t meet our credit quality requirements

(that is, it must be an ‘Investment Grade’ issuer) or minimum issue size and maximum delta (if any).

Securities not meeting these criteria will not be considered for portfolio inclusion. Our portfolio construction

approach generally takes a long term view, with the expectation that we will buy and hold securities until

maturity, although we actively trade the portfolio where risk adjusted valuations move beyond our tolerance

bands or to take advantage of mispriced securities.

Risk Management

MPPM has a robust risk management process in place. It starts with a set of risk constraints that form the

investible universe and cascades through the process to how an investment is approved for inclusion in a

portfolio. From there, we have daily client level controls in place that flow through mandate compliance and

security and trade monitoring.


Strategy Performance & Volatility Charts The following two charts highlight the positive returns achieved, during volatile equity market conditions

during recent years, with less volatility than the equity market.

Chart 6: MPPM Diversified FI Strategy vs. the All Ordinaries Accumulation Index

MPPM Diversified Fixed Interest strategy gross return (with imputation) vs Domestic Equity market Period: Jan 2010 - Dec 2012

-15.0%

-12.5%

-10.0%

-7.5%

-5.0%

-2.5%

0.0%

2.5%

5.0%

7.5%

10.0%

12.5%

15.0%

17.5%

20.0%

22.5%

25.0%

27.5%

30.0%

32.5%

3/01/103/02/103/03/103/04/103/05/103/06/103/07/103/08/103/09/103/10/103/11/103/12/103/01/113/02/113/03/113/04/113/05/113/06/113/07/113/08/113/09/113/10/113/11/113/12/113/01/123/02/123/03/123/04/123/05/123/06/123/07/123/08/123/09/123/10/123/11/123/12/12

MPPM Diversified FI Strategy Gross Return

ASX 200 Equity Accumulation Index Return

Source: MPPM, Iress, Jan 2013, Prior to fees.

Chart 7: Daily Volatility of MPPM Diversified FI Strategy vs. Australian Equity Market

Daily Volatility: MPPM Australian Diversified FI Strategy vs Equity MarketPeriod: Jan 2010 - Dec 2012

-5.0%

-4.0%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

3/01/20103/02/20103/03/20103/04/20103/05/20103/06/20103/07/20103/08/20103/09/20103/10/20103/11/20103/12/20103/01/20113/02/20113/03/20113/04/20113/05/20113/06/20113/07/20113/08/20113/09/20113/10/20113/11/20113/12/20113/01/20123/02/20123/03/20123/04/20123/05/20123/06/20123/07/20123/08/20123/09/20123/10/20123/11/20123/12/2012

MPPM Diversified FI Strategy

ASX 200 Equity Accumulation Index

Source: MPPM, Iress, Jan 2013


The following chart highlight the positive returns achieved, compared to the domestic bond market

Chart 8: MPPM Diversified FI Strategy vs. the UBS All Maturities Composite Bond Accumulation Index

MPPM Diversified Fixed Interest Strategy Return vs. Domestic Bond Market ReturnPeriod: Jan 2010 - Dec 2012

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

3/01

/201

0

3/02

/201

0

3/03

/201

0

3/04

/201

0

3/05

/201

0

3/06

/201

0

3/07

/201

0

3/08

/201

0

3/09

/201

0

3/10

/201

0

3/11

/201

0

3/12

/201

0

3/01

/201

1

3/02

/201

1

3/03

/201

1

3/04

/201

1

3/05

/201

1

3/06

/201

1

3/07

/201

1

3/08

/201

1

3/09

/201

1

3/10

/201

1

3/11

/201

1

3/12

/201

1

3/01

/201

2

3/02

/201

2

3/03

/201

2

3/04

/201

2

3/05

/201

2

3/06

/201

2

3/07

/201

2

3/08

/201

2

3/09

/201

2

3/10

/201

2

3/11

/201

2

3/12

/201

2

Date

Ret

urn

MPPM Diversified FI Portfolio Cash ReturnDomestic Bond MarketMPPM Diversified FI Portfolio Gross Return (includes imputation credits)

Source: MPPM, Iress, Jan 2013, Prior to fees.

SUMMARY We employ a rigorous research process with respect to the MPPM Diversified Fixed Interest strategy, and

have been managing fixed interest portfolios since 2000. Our research and experience supports our current

view that the IRS sector is offering attractive margins over bank bill swap rates, whilst bond markets can

continue to offer a hedge should the economic outlook deteriorate.

The IRS market provides a lower risk alternative to equity markets, with a tax effective regular income

stream. Its structure and diversification provides investors with an option to source a reliable income

stream at attractive margins.

Should you have further questions about MPPM’s Diversified Fixed Interest strategy or its suitability for

inclusion in your portfolio, please contact your adviser for more information.


This document contains purely factual information and/or general advice and does not take into account your objectives, financial

situation or needs and, before acting on this information, you should consider whether it is appropriate to your situation.

Macquarie Equities Limited is a related body corporate of Macquarie Private Portfolio Management Limited and will receive brokerage

in respect of transactions entered into on your behalf by Macquarie Private Portfolio Management Limited.

This discussion paper and investment strategy is indicative only. The appropriateness of the investment strategy referred to in this

document is general in nature only; it should not be construed as a general endorsement of the investment strategy as being

appropriate for all investors. Potential investors are advised to seek professional legal, financial and taxation advice on the

implications of investing with respect to their own particular circumstances.

This paper has been prepared by Macquarie Private Portfolio Management Limited ABN 26 089 987 388 (“MPPM”) Australian

Financial Services license no. 237506 and is current as at March 2013.

Macquarie Enhanced Australian Fixed Interest Fund ARSN 085 130 794 (“Fund”) is offered by Macquarie Investment Management

Limited ABN 66 002 867 003, AFSL 237492 (“MIML”). Investments in the Fund are not deposits with or other liabilities of Macquarie

Bank Limited ABN 46 008 583 542 or any Macquarie Group company and are subject to investment risk, including possible delays in

repayment and loss of income or principal invested.

None of Macquarie Bank Limited, MIML or any other member company of the Macquarie Group in any way stands behind or

guarantees the performance of the Funds or the repayment of capital from the Funds or any particular rate of return.

This presentation contains factual information and/or general advice and does not take account of your objectives, financial situation

or needs. Due care and attention has been used in the preparation of any forecast information, however actual results may vary from

forecasts and any variation may be materially positive or negative.

No members of the Macquarie Group give, nor does any member purport to give, any taxation advice. The taxation information in this

document is based on laws current at the time of writing. The application of taxation laws to each investor depends on that investor’s

individual circumstances. Accordingly, investors should seek independent professional advice on taxation implications before making

any investment decisions.

This paper is based on information obtained from sources believed to be reliable but we do not make any representation or warranty

that it is accurate, complete or up to date. We accept no obligation to correct or update the information or opinions in it. Opinions

expressed are subject to change without notice. No member of the Macquarie Group accepts any liability whatsoever for any direct,

indirect, consequential or other loss arising from any use of this research and/or further communication in relation to this research.

Past performance is not a reliable indicator of future performance. Any forecasts contained in this presentation, are predictive in

character and therefore investors should not place undue reliance on the forecast information. The forecasts may be affected by

incorrect assumptions or by known or unknown risks and uncertainties. The actual results may differ substantially from the forecasts

and some facts and opinions may change without notice.

The Macquarie Group or its associates, officers or employees may have interests in the financial products referred to in this

presentation by acting in various roles including as investment banker, underwriter or dealer, holder of principal positions, broker,

lender, director or adviser. Further, they may act as market maker or buy or sell those securities as principal or agent and, as such,

may effect transactions which are not consistent with the recommendations (if any) in this presentation. The Macquarie Group or its

associates may receive fees, brokerage or commissions for acting in those capacities and the reader should assume that this is the

case.

References to S & P in this presentation are references to Standard & Poor’s (Australia) Pty Ltd ABN 62 007 324 852

Credit-related analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed

and not statements of fact or recommendations to purchase, hold, or sell any securities or to make any investment decisions.

Date post:	13-Mar-2018
Category:	Documents
Upload:	haminh
View:	222 times
Download:	1 times

MACQUARIE PRIVATE PORTFOLIO MANAGEMENT · PDF fileMacquarie Private Portfolio Management . 1....

Documents