Bond yields fall to all time lows - or less - on inflation expectations

This week saw the first instance of a negative interest rate bond issue by the Australian government. Now while the bond market in Australia is not as well understood or as large as it is overseas, and as such it didn't make the front pages of even the financial press, the event is pretty significant.

For the record the actual negative interest rate was -0.07%, so in actual terms it's pretty marginal, as was the size at $200m of the actual issuance. Equally the 10 year bond yield traded at an all time low yesterday of 2.27% per annum yesterday. However the reality is that some investors have bought Australian government bonds on which they will effectively PAY the government 0.07% per annum for the privilege. As the good doctor would once have said: "why is it so"?

Our understanding is threefold: firstly various investors and institutions in Australia are required to hold a portion of their assets in government bonds. In that event they have no choice, although they do have a choice of which issue to invest in.

Secondly, overseas investors believing that their currency (such as the Yen) might actually fall vs the A$ will be playing the currency trade.

Finally the fact that this issue attracts a negative interest rate is an indication that inflation, (currently 1.7% pa) going forward is expected to fall further, and remain below the RBA's official cash rate. This historically low inflation rate is a real concern for the government and the economy, even though it may be welcomed by sections of the community, simply because it indicates limited, or potentially zero (or worse) economic growth.

Which leads us to the government's more immediate issue, namely the forthcoming budget.

One somewhat tricky point for the government while trying to manage the economy is that they comprehensively fluffed last year's budget to the extent that various measures have yet to pass the Senate. So lopsided, and in our humble opinion, poorly devised and subsequently communicated was last year's budget that many of its key features have had to be abandoned, and in doing so any element of political capital the government might have had has now evaporated.

So just when the country is in desperate need of long-term thinking and budgetary reform, it is unlikely we are going to get it. Having just announced a tax White Paper the Prime Minister has already ruled out various options (including the abolition or scaling back of negative gearing) that might have been recommended simply because they would be politically unacceptable to the government's support base.

Equally it would appear that any change to the GST, whether by increasing the current rate from 10 to 15%, to bring it more in line with most other developed countries, or by broadening it to include the other half of the economy which is currently GST free, would seem to be a bridge too far for the government's current standing in the opinion polls. Hence the only real GST debate we are currently seeing is the squabbling between State premiers, which make them look much like siblings or cousins at the reading of great aunt Thelma's will.

As a result it looks like this year's budget will include the usual tinkering around the edges, some of which will be unpopular and some popular, but all with an eye on how many votes might be won or lost as a result. Sadly what we need is a strong and reforming government which can make the hard but necessary decisions to overcome the current budget woes and set the country on the course of a sustainable economic footing.

Specific results received this week include the following MARCH PERFORMANCE UPDATES:

The Bennelong Long Short Equity Fund returned 3.59%, to being the performance over the latest 3 months to 6.40%.

Laminar Credit Fund rose 0.54%, to bring the Fund's annual performance since inception to 19.33% pa.

The Monash Absolute Investment Fund returned 1.1% in March, when the Australian Equity Market fell slightly -0.09%.

QATO Capital Market Neutral Long/Short Fund rose 3.12%, bringing the Fund's performance for the last 6 months to 25.16%.

Chris
CEO, AUSTRALIAN FUND MONITORS

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ALPHA BETA ASIAN FUND

ATTACHED FILESAlpha Beta Asian Fund AFM Fund Report Feb 2015 (pdf format)

Absolute Return: Chasing Yield - high risk, but is there no alternative?

A recently published report from S&P Dow Jones comparing Index versus Active Funds gained (not surprisingly) some coverage this week, primarily as it showed that in the six months to December 2015 Active funds had underperformed Index funds (and therefore presumably the index itself). The S&P scorecard showed that 8 out of 10 Australian active funds had underperformed their benchmark in all the major sectors barring domestic small caps.

However Active funds come in all shapes and sizes, and AFM's figures for equity based Absolute Return funds for the 12 months to December 2014 show that 60% outperformed the ASX200 accumulation index. To be fair that percentage has dropped somewhat for the 12 months to March 2015, thanks largely to the market's return of almost 7% in February, taking the YTD return to 10.29%.

A swift response from Epoch Investment Partners ensued pointing out the distorting effect of QE which was creating a false investment environment, and that talented active "stock-picking" managers would prove their value again once QE had passed. Actually, QE has already finished in the US, although the effects are lasting longer than imagined, while in other parts of the world it is ongoing.

In Australia QE was avoided, probably in part thanks to the mining boom which most will have noticed is long gone, and now in bust mode, relatively speaking. However interest rates remain in a downward trajectory, with the economy appearing close to stagnation, with Sydney's property boom probably the only thing preventing the RBA from cutting rates a further 25 bps earlier this week.

However, investor's obsession with the yield play, described by Optimal Australia's George Colman in their most recent performance report as TINA, or "There Is No Alternative" is indicative of the distorting effect of the current interest rate environment, which is making it difficult, or at least expensive for long/short managers to either short poor stocks which are benefitting from the rising tide, or be comfortable holding good stocks at seemingly unattractive prices.

As many managers, including Optimal, are pointing out, this must all end in tears eventually, and even though portfolio insurance is a difficult and costly exercise, this is certainly no time to drop it. As an example, even though only 28% of results are to hand for March, equity based hedge funds returned 1.39% for the month, against the market's flat (-0.09%) return.

Specific results received this week include the following RECENT PERFORMANCE UPDATES:

Alpha Beta Asian Fund rose 0.45% to bring the Fund's return since inception to 21.40%.

The KIS Asia Long Short Fund was flat (0.09%) in February. Since inception the Fund's annual return was 14.61% p.a.

Chris
CEO, AUSTRALIAN FUND MONITORS

Connect with me on LinkedIn Twitter