One way to reduce volatility in portfolios is to invest in Floating Rate Notes (FRN’s), the ‘Cinderella’ of the fixed interest market.
Sydney based Spectrum Asset Management, which manages some $75 million for its clients, is a specialist in holding this inadequately understood type of bond whose income goes up in tandem with official rates.
When could rates rise?
In a world where rising interest rates usually mean dropping bond values, it’s interesting to note that some professional managers hold most of their portfolios in FRN’s which in turn don’t suffer from that problem.
“More than 80 per cent of our core fund is in FRN’s”, says Spectrum Head of Research Damien Wood, who adds that such bonds are widely held by Institutional Portfolio Managers (due to their investible scale). But they are often hard for retail investors to access.
“We’re holding around 35 domestic and international company securities now and the average credit rating of our fund is typically ‘Single-A’, “says Damien, who has been working for over 25 years in Australia, the U.K and Asia in specialist credit markets. The broader Spectrum team has a combined over 100 years of credit management experience.
Almost 50 per cent of Spectrum’s holdings are in bonds issued by Australian and International banks in roughly equal measure, with the balance made up of assets from industrial, infrastructure, property, and Residential Mortgage Backed Securities (RMBS’s).
Between 10 and 15 per cent of the fund is held in cash, not only to give the fund the firepower to get quick access to under-priced bonds in the market, but also to allow investors daily liquidity in case they need to redeem their investments.
Liquidity and access have long been a problem for retail investors in Australia looking to get into the bond market, even though in this country it is actually around the same size as the stock market.
The Spectrum model greatly reduces both of those problems, without adding to risk.
Navigating heavy traffic
“The portfolio construct is straightforward. Investments in securities, all in Aussie dollars and no derivatives”, he says of the Spectrum product, which has enjoyed 23 months of positive monthly returns in a row and is currently earning investors just over 5 per cent a year.
That’s above the fund’s target rate of 1.5 per cent over the RBA cash rate, which is also currently 1.5 per cent. That makes 3 per cent in total, significantly ahead of short term bank deposit rates.
“Volatility is typically low in the corporate FRN market,” he points out, adding that the type of companies issuing this type of bond tend to have very strong balance sheets to qualify for investment grade ratings from Rating Agencies.
“Importantly, we’ll never buy anything that we wouldn’t hold on our own personal account,’’ he adds.
Awareness that a rocky road may be ahead at any time always requires good drivers. In which case the Spectrum team’s experience will help to see the way through.
For further information contact Jarrod Brown.
Written by Andrew Main. Long established and objectively minded financial journalist, Andrew Main has an eye for what counts for investors. (@31/10/17)