Protection from 'unknown unknowns' Ardea Investment Management January 2025  "...as we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns- the ones we don't know we don't know" ― Donald Rumsfeld, former US Secretary of Defence Named after Janus, the Roman god often depicted with two faces (one that looks to the past and one to the future), January is the month of new beginnings. The month we put lessons from the past year into action, and the month we navigate the economic predictions for the year ahead that fill our LinkedIn feed. If we can learn anything from the recent past, it is to expect the unexpected. The late Byron Wein was famous for his 10 Surprises list, a tradition he started in 1986 while working as chief US investment strategist at Morgan Stanley. Wein defined a 'surprise' as an event that the average investor would only give a one in three chance of happening, but that he believed was 'probable'. Effectively, a list of unlikely 'known knowns'. Meanwhile, at the start of each year, the World Economic Forum issues its Global Risks Report that explores the most severe risks that the world could face over the next decade. Providing a useful macro framework for exploring potential risks that could affect investment portfolios, the report highlights the 'known' events, where timing or the extent of the impact is unknown. As the pandemic proved, 'unknown unknowns' that turn the world (and portfolios) up-side down, exist. Life as we knew it locked down in March 2020, but the WEF report, published in January of that year, had no mention of pandemics in the near or distant future. We start this year with a few 'known knowns'. Timing, however, is frequently the 'known unknown'. Donald Trump's taking office at the presidential inauguration on 20 January 2025, for example, is a known. The impact of his selected administration over time, less so. The same could be said for the Federal Reserve's next moves, or how Elon Musk will wield his newfound political clout. Analysts forecast more gains in the global equity markets[1], while primary fixed income markets have raced enthusiastically into 2025. In European financials, there was issuance across the capital structure, while Goldman Sachs predicted that corporate bond issuance could be as high as $1.5 trillion in 2025[2]. Warren Buffett's multi-billion dollar move to cash in 2024 signals something, but what? Economists and strategists can fill our feeds and inboxes with probabilities of an economic downturn; likelihoods of an inflationary uptick; and 'evidence' of overvalued markets (incidentally all assumptions made around Buffett's equity sell off last year), but the reality is predictions just make for good headlines. In the end, they are little more than speculation. From unfinished wars, to the migration impact and insurance burden of, as we witness right now in Los Angeles, increasingly unstable and violent climate patterns, managing a portfolio that defends against the 'unknowns' and reaps rewards for selecting the correct 'knowns' (at the right time) is not for the faint hearted. And let's not forget our favourite protagonist, the one we love to hate: volatility. While volatility across the financial markets is almost certainly one of 2025's 'known knowns', the magnitude and timing is, once again, unknown. Trump's return ramps up the unpredictability in an already volatile world. So, if the outcomes of predictions are unreliable, and the improbable can become reality, how can trustees position portfolios for the unexpected? Diversification is the classic defensive play. For this, there is a new contender on the block. Almost exactly a year ago, the Securities and Exchange Commission approved spot exchange-traded products[3], triggering billions in new liquidity and normalising Bitcoin as a legitimate investment vehicle. As a result, Bitcoin breached the $100,000 mark attracting it interest from institutional investors, retail traders and governments[4]. With institutional adoption, regulatory developments (expected to be lighter under Trump) and technological advancements, will cryptocurrency become the 'diversifier' du jour? It almost does not matter. There will always be a fashionable asset class or 'fail safe' way to structure portfolios. Anyone remember risk parity or the UK's liability-driven investment crisis? Fixed income, however, will always be a 'known known' in a multi-asset class institutional portfolio. Think comfort food on a cold winter's day. Conventional fixed income investing, however, is largely based on accumulating bonds to harvest yield or trying to predict the direction of the markets. Moreover, bonds now come in all shapes, sizes, maturity, duration, and risk profiles. From government bonds right through to high yield private debt, the credit spectrum now comes with its own warning label. This is where Albert Einstein's theory of relativity might help. Einstein stated that space and time are relative and that motion must be relative to a frame of reference. So, rather than looking to reduce risk by managing the correlation between bonds and equities in a portfolio, we believe that it is the relative volatility between the two asset classes that matters. And it's worth noting that high-quality government and semi government bonds are typically less volatile than corporate bonds, which can have a connection to the general performance of the underlying company's stock. But irrespective of what the bond markets may do in 2025, instead of worrying about what the future holds or messing about with the timing and quantities of ever more complex types of credit, key to managing the risks of 'known unknowns' and 'unknown unknowns' is, we believe, an increased allocation to bonds that will be able to reduce the volatility of the portfolio if the bond volatility is lower than equity volatility (even if the correlation is positive).

Funds operated by this manager: Ardea Australian Inflation Linked Bond Fund, Ardea Real Outcome Fund

[1] www.nytimes.com/2024/12/31/business/stock-market-2025-predictions.html [2] www.goldmansachs.com/insights/articles/companies-may-issue-one-point-five-trillion-dollars-of-us-bonds-in-2025 [3] https://www.sec.gov/newsroom/speeches-statements/gensler-statement-spot-bitcoin-011023 [4] https://www.forbes.com/sites/digital-assets/article/bitcoin-price-prediction-2025/   Important Information This material has been prepared by Ardea Investment Management Pty Limited (ABN 50 132 902 722 AFSL 329 828) (Ardea IM) for wholesale investors only. It is general information only and is not intended to provide you with financial advice or take into account your objectives, financial situation or needs. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. Any projections are based on assumptions which we believe are reasonable but are subject to change and should not be relied upon. Past performance is not a reliable indicator of future performance. Neither any particular rate of return nor capital invested are guaranteed.

Restoring (and retaining) balance Ardea Investment Management November 2024 With Trump trades flooding the equity market in the run up to the US elections; a sell-off in the treasury markets since then; and Bitcoin hitting an all-time high this month, it is fair to say, that for some investors at least, the last few months have been a bare-knuckle roller-coaster ride. In a quest to retain balance in portfolios, where can investors go to both avoid mercurial shocks and achieve returns? Traditionally, fixed income has been the yin to equity's yang. But is this still the way to restore balance to the books? The answer depends on the 'how' of fixed income. Right now, the pursuit of higher yields is driving demand for investment grade corporate bonds, which are less liquid than their government bond cousins. However, fixed income investing is teetering ever closer towards untested territories with the inexorable rise of private credit. This unrated end of the credit spectrum, which is even less liquid than investment grade corporate bonds, has been gathering momentum over the last 15 years, and according to Morgan Stanley's[1] estimates, could reach $2.8 trillion by 2028. Add in music royalties, auto loans, residential mortgages, franchise finance and infrastructure debt, and by a private global markets firm's estimate, the total addressable private debt market may be as much as $40 trillion[2]. The recent avalanche of assets cascading into private credit has come from insurers[3], who traditionally keep high allocations to fixed income. To satiate their need for returns, insurers are raiding other parts of their portfolio, such as private equity, to fund this credit buying spree.   This may explain why we are seeing so many private equity behemoths diving into this corner of fixed income; an access point to the recurring fees from managing insurance capital; a market that itself is expected to reach almost $10 trillion by 2028[4]. Blackstone[5], for example, has integrated its corporate credit, asset-based finance, and insurance groups into a single new unit. Meanwhile, Brookfield and KKR & Co. have taken majority stakes in, or bought outright, insurance companies, prompting Moody's to issue a warning on what it calls a balance-sheet heavy approach earlier this year[6]. Private credit, originally a peripheral player in the non-league of asset classes, was the domain of smaller companies and sub-prime borrowers. But now these large alternative asset managers control this income stream, the tables have turned. Offering fixed income-like lower volatility and equity-like higher returns with a deal flow that is uncorrelated to private equity activity, private credit is being hailed as the diversifier for turbulent times ahead.   But is it really? Its systemic credentials have not yet been tested, during a prolonged economic downturn, for example. Moreover, as it is still under the radar of financial regulators, private credit still has more leeway than banks, the traditional lenders whose antics were nipped in the bud after the Global Financial Crisis. The issues with private credit include the potential lack of transparency; less oversight and accountability; a dearth of credit ratings; liquidity and conduct risk; and potential for elevated losses in a recessionary environment. And, from a geographic perspective, according to Pitchbook's 2023 Global Private Debt Report[7], of the current $1.6 trillion global private debt market, the lion's share, around $1.1 trillion, is in the US. As the world waits for Trump and his largely politically untested team to take office in January, and the spectre of war still looms on the horizon, no-one can bet with certainty on interest rate direction and whether or not fiscal further tightening is on the cards. If rates do rise, then loans with floating rates will adjust and deliver higher returns, so no problem. Fiscal tightening, however, will see private credit spreads contract and the liquidity premium in investment grade segments of private credit markets may decrease.  All of these are worries that keep investors awake at night. So where can investors find Zen in an increasingly turbulent world? Is there an investment that is agnostic to the whims of politics; the increasing probability of more war; and the prevailing macro-economic environment and guarantees portfolio peace of mind during market turbulence? No. But without ignoring interest rate and global macro risks, investors can change the way they view the interaction between asset classes, and in turn, protect the downside and still harvest the returns. To harness the power of fixed income to restore and retain balance in a multi-asset portfolio, investors need to understand one key concept: bonds do not need to be negatively correlated to equities to reduce portfolio risk. What really matters more than the bond/equity correlation is the relative volatility between the two asset classes. From this perspective, bonds provide the necessary diversification if bond volatility is lower than equity volatility, even if the correlation is positive. Obviously, analysis shows that, while better outcomes can be achieved under negative correlation, this is secondary to the impact of relative volatility. Negative bond correlation is therefore not necessary to deliver better diversification to an equity heavy portfolio, making bond volatility a more influential factor on returns than correlation. Taking this a step further, when building up a defensive portfolio to guard against expectations of volatility, the often-overlooked government bond is actually typically less volatile than its corporate bond cousin, which can have a linkage to the general performance of the underlying company's stock. So rather than focusing on yield harvesting or interest rate and credit spread predictions, the key to restoring balance in a multi-asset portfolio is to mine for relative value in inefficient and inconsistent pricing between securities, such as high-quality government and semi government bonds, which have similar risk characteristics and are duration-neutral, credit-free, and shake less when volatility, likely around election time, comes calling.

Funds operated by this manager: Ardea Australian Inflation Linked Bond Fund, Ardea Real Outcome Fund

[1] www.morganstanley.com/ideas/private-credit-outlook-considerations [2] www.apollo.com/strategies/asset-management/credit/investment-grade-private-credit [3] www.institutionalinvestor.com/article/2bsts917gtgnemd4q3w8w/portfolio/the-private-assets-insurance-companies-want-in-2023 [4] https://www.statista.com/statistics/1192960/forecast-global-insurance-market                 [5] www.blackstone.com/news/press/blackstone-integrates-leading-credit-and-insurance-businesses-to-form-blackstone-credit-and-insurance-bxci-in-push-toward-next-1-trillion/ [6] www.ft.com/content/de6eb245-80ff-4f9c-b2ed-7a415538512b [7] https://pitchbook.com/news/reports/h1-2023-global-private-debt-report Important Information This material has been prepared by Ardea Investment Management Pty Limited (ABN 50 132 902 722 AFSL 329 828) (Ardea IM) for wholesale investors only. It is general information only and is not intended to provide you with financial advice or take into account your objectives, financial situation or needs. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. Any projections are based on assumptions which we believe are reasonable but are subject to change and should not be relied upon. Past performance is not a reliable indicator of future performance. Neither any particular rate of return nor capital invested are guaranteed.

Troubled times ahead? Ardea Investment Management April 2024 The saying that all good things must come to an end is a bittersweet reflection of reality. Sadly, too many of us fail to appreciate those good times, often focusing on what could or might go wrong. Perhaps this is understandable given the potential for higher interest rates to stifle economic growth and an increasingly complex geopolitical environment. However, financial markets have delivered investors a stellar twelve months of performance. The Dow Jones Industrial Average and S&P 500 have both reached record highs in the US, as did the Stoxx 600 in Europe and Japan's Nikkei 225. Corporate bonds have also performed well, with the spread over similarly dated government bonds approaching historically tight levels in both the investment grade and high yield markets. Can the good times continue? It is looking increasingly likely that forecast aggressive interest rate cuts are no longer on the way.  In fact, "higher for longer" appears to be the base case for a growing number of central banks with inflation remaining stubbornly above the average 2% target. US inflation, which has become a bellwether for market expectations unexpectedly rose from 3.1% to 3.2% in February, while core inflation which excludes volatile food and energy prices remained closer to 4%.  A similar trend is evident in other developed market economies such as the United Kingdom, Australia, and the Eurozone where central banks are now forecast to begin trimming interest rates in May or June - far later than previously forecast. Higher interest rates are already impacting the corporate sector, and this is where we could see the first cracks of a financial market correction. In many industries, the combination of higher input and financing costs mean that capital expenditure has been curtailed and cash stockpiles are low. Debt finance which was readily available and cheap is now falling due with nearly $1.5 trillion of high-yield debt, including loans, maturing globally through the end of 2026, of which $882 billion is U.S. debt, according to S&P Global. Bonds account for some $338 billion of that total with $53.8 billion maturing this year, $125.5 billion next year, and $158.6 billion in 2026. Refinancing that debt presents a challenge on two fronts, with the first being affordability. Interest rates have risen very significantly in recent years meaning the cost of refinancing these bonds will have also risen and for some corporates these higher rates will be unaffordable. The second challenge is one of demand. The spread over supposedly low risk government debt has narrowed, limiting the upside of corporate debt for investors, and shining a bright light on current valuations. Defaults have been surprisingly resilient, but that could change and the impact on demand will be immediate. Furthermore, the process of quantitative tightening has sapped liquidity from the financial system. Inflows into the US Federal Reserve's overnight reverse repo facility, a proxy for excess cash in the financial system, have been falling sharply for over twelve months. Once cash drains from the reverse repo facility, bank reserves at the Fed are likely to fall, further tightening financial system liquidity, and potentially hitting demand for corporate debt as well as equities. The high cost of debt finance, lofty valuations and a rapidly approaching wall of maturing bonds at a time where economic growth is forecast to slow are all reasons for investors, particularly those in the corporate bond market to be cautious. Yet, flows into the corporate sector remain strong and this we believe is purely a function of forecast interest rate cuts later in the year. Should those interest rate cuts fail to materialise and concerns around corporate debt come to fruition, many investors could be over exposed to rapidly falling asset class. Unlike traditional bond investment managers, our relative value approach is duration neutral and excludes credit. Investment performance is independent of the level of bond yields, the direction of interest rates and macro-economic variables. Consequently, relative value portfolios are excellent diversifiers of traditional fixed income and equity market risk, often appreciating when these asset classes are in retreat. The economic outlook remains uncertain and as such, the outlook for financial markets is also uncertain.  We believe now more than ever it is important for fixed income investors to look past the consensus view when structuring their portfolios, adding assets that are able to weather a wider variety of economic and financial market conditions.

Funds operated by this manager: Ardea Australian Inflation Linked Bond Fund, Ardea Real Outcome Fund

Important Information This material has been prepared by Ardea Investment Management Pty Limited (ABN 50 132 902 722 AFSL 329 828) (Ardea IM) for wholesale investors only. It is general information only and is not intended to provide you with financial advice or take into account your objectives, financial situation or needs. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. Any projections are based on assumptions which we believe are reasonable but are subject to change and should not be relied upon. Past performance is not a reliable indicator of future performance. Neither any particular rate of return nor capital invested are guaranteed.