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Australian Shareholders Association Podcast with Brad Dunn of ECAS, ECOR and EMAX

Background to the Australian Shareholders’ Association Podcast: The Equity Investor Journey

Well this is a bit exciting. The Australian Shareholders’ Association is a prominent and active association representing the interests of Australian shareholders. Brad Dunn, Senior Credit Analyst of eInvest’s three Active Fixed Income ETFs was interviewed on their podcast, The Equity Investor Journey.

Typically, investors involved with the Australian Shareholders Association are normally focused on listed shares, and are very active investors. That said, fixed income markets globally are almost triple the size of the listed shares market, so it’s a great place to target a steady return.

Since eInvest launched three Active ETFs investing in Fixed Income late last year, we are so excited to have Brad featured on this podcast as we think Active ETFs are the superior way for direct investors to access the fixed income market, especially investors who are already used to buying and selling stocks and ETFs on the exchange.

The Funds

Brad Dunn is the Senior Credit Analyst of our three Fixed Income Active ETFs. Click the links below to find out more about each fund.

All three of these active ETFs aim to distribute income back to investors on a monthly basis. To invest, type the code of the fund that you prefer into your online broker to invest.

Keep in touch

Sign up here to our comms to receive more news from us. Have questions? Email us at [email protected]

Additional Resources and reading  

Brad covered a number of important topics regarding the how’s and why’s of investing in Active fixed Income ETFs.  Read more at the following links:

A big thank you to Phil Muscatello, The Australian Shareholders Association and the Equity Investor Journey for having us!

Disclaimer: Please note that these are the views of the writer, Jodi Pettersen and Brad Dunn of eInvest and is not financial advice.

To find out how to invest in our active ETFs, visit here. The product disclosure statement and more can be found at www.einvest.com.au

If you’d like to keep learning further, please feel free to follow any of our socials listed below.

Podcast Transcript

Listeners should refer to the disclaimer in the episode notes and at the end of this podcast, one of the biggest factors that determine the success of companies over time is their ability to manage debt prudently. And obviously, the more you borrow, the more you’ve got to pay back and the greater stresses they can place on businesses, especially in times like recessions.

 

Good day and welcome to the Equity Investor Journey brought to you by the Australian Shareholders Association. I’m Phil Muscatello. With interest rates at historic lows, where can investors find fixed income? These are uncertain times, and even traditional yield earners like banks, are facing ongoing challenges. Brad Dunn is the senior credit analyst from eInvest Fixed Income Active ETFs, and he joins us to talk about the challenges of finding a place for cash.

 

Hi, Brad. Thanks for coming on the podcast. Thank you.

 

Let’s start by talking about interest rates. What’s happened and where do you see them going?

 

Sure. So interest rates, as you’re probably aware, anyone with even a cursory glance at financial markets lately would have noticed that interest rates are at effectively at historic lows. And the reality is, we think that those interest rates are going to stay low for an extended period. I think if you look at central banks and governments, they’re very keen to keep those rates low for a number of reasons. If you’re the government, you want to see those rates low because they’ve got a lot more debt on their on their books now. And they’ll need to make sure that they can fund that debt and lower the interest rate, the easier it is. And if you’re a central bank, then you also need to be looking a little bit broader across the economy. And you’re going to hope that, you know, residential property investors and investors more generally are going to be able to service their debts as well. And the lower you keep interest rates or other things being equal, the easier it will be for them to manage those debts.

 

But is it totally driven by government?

 

Not no, not really. No. The markets are certainly very involved in this because market investors, especially corporate and government bond investors, need to think out into the future, just like all investors, really. But bond investors especially need to think what is the economic outlook for the next three years, five years, even 10 years? And they expressed those views through the interest rates that they’re willing to accept on government bonds and bonds as well. So that’s really the main driving factor. But it’s fair to say that governments and central banks are very important in signalling to the market what they believe will happen in the future. And market participants will take their decisions based on their own view and the signals that the governments and central banks are giving as well.

 

Some investors I’ve talked to feel that interest rates are going to be going up very quickly because of the amount of liquidity that’s being pumped into the system by governments.

 

So, when we talk about liquidity, we’re talking about actual available money in the system. And I suppose basic economics states that if there’s lots of new money coming into the system, then it’s going to be more available. So, there’s going to be more avenues to reach it by whatever means you can you can access it. So, it’s not it’s not a strong argument for interest rates to go up. So, interest rates go up when there’s a lack of cash in the system and then more and more people are going to be competing for that limited amount of funds. So, I believe that the opposite would be true if there’s lots of liquidity being pushed into the system. It’s, to me, an argument for interest rates to remain lower for longer.

 

So, with interest rates so low, what’s this mean for investors?

 

Yeah, that’s the challenge for investors remains and is probably only going to intensify. So, these low rates, especially in the fixed income space, means that any new dollar that’s invested into the market today is locking in those rates for however many years the particular bond investment is for. We’re taking a step back. If you look at low interest rates from the perspective of how it affects equity investors, the theory goes that as the discount rate for future cash flows drops, the value of those future cash flows increases and you’re willing to pay more for it for an equity today. The problem with that assessment as we sit here today is that we’re on the precipice, or maybe even already in quite a large recession, both here in Australia. But I think globally as well, we’re going to be going into a recession that is probably going to last at least a couple of years. So, I think there’s a quite a bit of tension between those prospects for investors saying, well, the cost of money is very cheap. And as we talked about, perhaps going to stay low for quite a long time. But am I really, willing to pay up for equity at these relatively elevated levels, given what we expect to be a quite an elongated recession? So, for bond investors, that same calculus is still true. But the bond investors, we’re sitting there much more closely thinking, okay. For any company that we invest in, what is the prospects that we’re going to get our money back in one, two, three, five years? And how easy is it going to be for that particular company to pay us our coupons every three months or six months or however long it is? So that’s sort of where we’re sitting at the moment. And I think investors across the asset class spectrum should be going through these sorts of things right now.

 

Your ETFs invest in corporate bonds and we’ll get onto that again in a few moments. But your funds are actively managed while many fixed income products are passive. Why pay management fees when you can just buy the index?

 

Yeah, it’s a good question. But I think when it comes to indexing for equities, I think the argument is very strong that rather than paying active management for funds that often don’t outperform over long periods. It’s advantageous to find a to find a product that invests in an index which is very broadly based. You know, invest in hundreds and hundreds of companies. But the way an equity index works is, generally speaking, it’s called market cap weighted. So, the larger companies, the more valuable companies will take a greater place in that index. And that that’s a good way to invest. I think over time, because you’re supporting businesses that are growing and you’re invested in businesses that are growing and increasingly so as they do. Well, now take, for example, the same logic and put it onto a fixed income index. What you’re essentially saying is they’re still structured like a market cap weighted index, but the market cap of a fixed income index is how much a particular company or government has borrowed. So invariably what you see is for a large government bond index, for example, you’re going to be overexposed to the likes of Japan, the United States, Italy. Even so, those are three countries that most people know, but they’re also the most highly indebted governments in the world for various reasons. So, when you when you buy a global corporate global government bond ETF, that’s effectively what you’re investing in.

 

Likewise, in corporate bond space, companies that have the best ability to access debt markets and, you know, borrow more generally tend to be overrepresented. So a fixed income index is it is effectively buying into companies that that can borrow or have borrowed a lot compared to others. And as we know, one of the biggest factors that determine the success of companies over time is their ability to manage debt prudently, not to avoid it altogether, but to manage debt prudently. And obviously, the more you borrow, the more you’ve got to pay back and the greater stresses that can place on businesses, especially in times like recessions.

 

So, some corporate bonds are better than others, like some governments are better than others.

 

Absolutely. Yeah. Yeah. So, we use a whole range of ways to delineate between different corporate bonds so we can obviously look at individual issuers and understand that the business lines that they’re in. So, for us, it’s you know, it’s very easy to distinguish between a company like Woolworths, which is in the consumer staples space. Everyone’s going to need to shop there now in five years and in 10 years’ time and some more speculative sectors and cyclical sectors such as, you know, some parts of the mining and energy space that can go through, you know, quite large cycles over. Over time. The second thing that we can use is credit ratings. So, credit, a credit rating is often misused, but we use them as effectively opinions of credit worthiness from third party entities. So, your listeners might have heard of names like Standard & Poors and Moodys. They’re two of the big ones. But they look at these companies from a range of from a range of viewpoints and put an opinion about what the credit quality of each of those issuers is. And we use them fairly extensively as part of our portfolio construction process. And then from there, it’s all about looking at other factors like the interest rate and turned to maturity and what they actually borrowing for and all of those sorts of factors that we can use as well.

 

So, it’s very much a case of just getting to know all of the types of bonds that we that we invest in. And the main point to make is that we can decide to not invest in a company at all if we if we don’t like one of those factors. If there’s a reason why we don’t like it, we’re not constrained by an index. So, we can just say that that particular name is not for us. So that’s really allowed us. So, you know, to really manage the portfolio quite conservatively and to avoid some names that would have given us some headaches had we invested because we had to. When you invest in a corporate bond ETF, you can often end up with several exposures that you would, as a personal investor, not be happy with. So, to give you some example, one of the main corporate bond ETF is in the United States at the moment, has about 18 percent of it exposed to the energy sector and more specifically, the shale oil sector. So, as you know, the shale oil sector is going through a tough time right now because oil prices are really low and they need much higher oil prices to be profitable. So, if you’re invested in a corporate bond ETF, a large corporate bond ETF in the US, 18 percent of your portfolio is exposed to these names.

 

Now, some of them will survive and unfortunately, some of them won’t. But the ones that don’t are going to sort of directly impact your returns because they’re simply not going to pay their coupons and repay their capital on time. And another example is Hertz, the car company that is in that index as well. So, by simply investing in that index, you have exposure to Hertz, whereas an active investor would have looked at that company for about 30 minutes and realized that it was just riddled with problems. It wasn’t really. They had to deal with something as drastic that is going to happen in our economy over the next two years. And it’s obviously, you know, succumb to it. It’s high debt load. So that’s just two examples. But, you know, when you invest in an ETF that has corporate bonds based on an index, you’re invariably going to give yourself exposure to those names. And in fixed income, the number one thing that you can do to protect your return is to avoid the defaults if you can avoid the defaults. You’ve done a large part of the work to getting to the types of returns that you would expect from fixed income.

 

Are there any defaults in examples of defaults that you’ve avoided?

 

Not defaults, per say. Overall, our funds are quite conservative. We don’t tend to go into the lower credit ratings and try and find that that that those types of returns. But we have taken some views on companies that we think we’re just a little bit too difficult based on other alternatives. One of those was AMP here in Australia. So, we did own AMP for a while. But the confluence of factors that included the royal commission and then selling a large part of their business to a two to a foreign company meant that there was a range of reasons. And we’ve only just seen in the last few days that Standard and Poor’s have decided to downgrade the rating on AMP because it because of all those changes. It’s a much different looking company than it was even two years ago. But we pre-empted that by several months and we made sure that we weren’t exposed to that. When that downgrade took place. So that’s I think that’s very much an example of active management sort of taking the view and making the decisions well before we were forced to do so.

 

So, are you investing in Australian only corporate bonds, but or internationally as well?

 

Predominantly Australian. But we do have some global exposure as well. So, we can get global exposure in a number of ways. We can look offshore and buy corporate bonds in other currencies, US dollars, euros. But our policy is to hedge it back to Australian dollars. So, an Australian investor won’t have any overt currency risk. But the other thing we can do is look at lots of companies that are domiciled offshore but feel that the Australian corporate bond market is a is an attractive place for them to issue. So, there are some banks that have branches here in Australia and they issue bonds out of that branch. So there really is exposure to a global bond. What’s the share of that? So, some of the Singaporean banks, for example, CBS Bank in New OBE and, you know, CBC out of Singapore, even banks as far afield as Sweden, for example, have branches here in Australia and will and will issue in Australian dollars. So that that gives us an opportunity to invest in in very interesting banks that are very well-run, very well capitalised, very high-quality banks rated the same as the Australian banks in Sweden’s case, for example, in Australian dollars. So that’s something that we think is quite powerful. And again, some of those bonds are expressed in indices and some aren’t. We’ve got the flexibility to look at all of them.

 

You alluded a moment ago to the sectors that you take into account. What are some of the sectors that you’re seeing as positive and some of the negatives at the moment?

 

Yeah, so we like we actually like banks. Funnily enough, at the moment, they’re certainly at the epicentre of the recovery process, but they’ve been able to do that because in the years following the GFC, they were forced to take some pretty radical changes to their business model. And over a number of years, they were able to raise more capital and make themselves stronger, remove some of the riskier parts of their business. So now, even though they are looking at some credit losses for the foreseeable future, which is which is unavoidable, of course, they’re in such a strong position to do that because of the work that they’ve done in the years leading up to it. So, they said so bank certainly are quite, quite well expressed in our portfolios across the board. And then in terms of some of the sectors, I mentioned one earlier in terms of consumer staples, it’s just it’s just one of those sectors that is quite defensive in saying that there are some defensive sectors that were perceived as defensive, that are really at the coalface of this at the moment. And one of those is airports. So, we’ve looked at airports and we’ve owned airports because in a normal course of events, there are wonderful business, almost monopolies in there in their city, multiple streams of revenue. And if you’ve been to Sydney Airport recently, you know that they make, you know, a fair coin out of you just by going to park and visit for half an hour.

 

So, they were very, very strong businesses and they form part of our portfolio. More recently, we’ve had to really reassess that thesis because our view is that air travel isn’t coming back anytime soon. So, we’ve sort of had to take some hard decisions. And one of those was to really reduce exposure to the airport sector, even though we believe that they will be fine, they will get through and their bonds will perform. The reality is we don’t know exactly how long that’s going to take. And the same goes for property as well. So, we invest in the debt of big property players. So your listeners will probably know the names Dexus and Lend Lease and so on. They often have investment trusts that hold particular assets that aren’t listed, but they will go out to the market and issue debt against those. Buildings, because, as you can imagine, you know, buildings with sort of, you know, large renter bases and long-term cash flows, it’s quite easy to sort of put debt against that sort of cash flow base. But again, what we’re what we’re seeing is what we think will be long term challenges to how those property owners utilize those assets going forward. As you know, less people are going to the shops, less people are going to the office, you know, working from home more these days.

 

So, while it’s not going to change next year, the three to five-year view is that there’s some of this office space will probably start to become available. And it’s hard to see who will start to take up that space over time. And one other point is the airlines themselves. So, as I mentioned, we take credit ratings very important. And Virgin had a bond out in the market. It actually listed a bond on the ASX in November of last year. There was a fair bit of demand for it. And it got away and got trading. But what really worried us was the lack of a credit rating. So, because it was so low in the capital structure, the ratings agencies weren’t keen to actually put a rating on it because in their view, was getting close to effectively being an equity like exposure anyway. So, but for that and another number of reasons, we didn’t look at that particular bond from Virgin. But overall, we don’t look at something if it doesn’t have a credit rating, because while we’re very confident in our own ability to sort of look at bonds and assess them, having that third party that that does it for a living is an additional two layer of protection that we can use as part of our process.

 

Many investors have looked at LICs in the past as a place to find income.

 

The reality is that there are some pitfalls to investing in an LIC when it comes to fixed income as well. The main one comes around because of the breakdown between the trading price and the underlying value. So, it’s fair to say that the underlying value of some of the assets in the fixed income items have been moving really quickly. And it’s very difficult for sort of average investors sitting at home that aren’t fixed income specialists to be able to look through a list of four or five hundred bonds and try and understand what their values are and then translate that into a trading price. So, typically what what’s happened over the last month or two is we’ve seen quite a strong improvement in in large parts of the corporate credit market after obviously historic falls. But the investors in the LITs have sort of taken the view that “we don’t necessarily believe that, too, to a certain extent”. So, while the market has bounced the LITs, sort of lagged in terms of the trading prices by between eight and 10 percent. So, I think I think that’s investors at home sort of taking the view that, “yes, it probably has recovered, but I’m not 100 percent sure. I’m not 100 percent confident. Therefore, when I put my bid in to buy one of these, I’m going to look at what they’re reporting is their net tangible assets and put a discount on it”. And I think that’s sort of starting to embed because in the last two months, it’s stabilized around that eight to 10 percent discount to two NTA.

 

Why did eInvest Decide to issue these is Active ETFs rather than LICs?

 

We decided on the active ETF structure because they have one inherent strength and that is being able to trade at NTA on a day to day basis. And they can do that because we have a market maker sitting over the top that makes sure that those prices remain quite close to NTA all the time.

 

So talk to us specifically about  your three active ETF. What are the similarities and differences between them?

 

We have three funds designed for different parts of the risk return spectrum. So, the first one is the Invest Cash Booster Fund, and that’s ECAS on the exchange. And it’s designed to generate a return of only about 50 basis points above the cash rate. Now, if you sort of trying to conceptualize what you would use that sort of fund for, think of ECAS as a parking spot for cash. So, you may have an inheritance, or you may have sold a property. Not quite sure you need to do with it with the cash just yet. ECAS is a fairly attractive way to hold that cash and it gives you really early access to it as well. Easy access over one to two days, however long it takes for you to settle a share trade. So, the second fund in our stable is the eInvest Core Income Fund ECOR, and that is a very conservative fund and it seeks to generate a return of 150 to 200 basis points over the cash rate. So, if you think if you think about that, our view is very much about capital preservation. It’s very much about low volatility. So, achieving returns that are quite stable over time.

 

And we also look to invest in only very highly rated assets. So, the average credit rating of the entire fund at the moment is A so that is that is quite high rated, but it has been as high as A plus in the past. So, we tend to we tend to move around in that range. So that’s that that’s a very high-quality credit rating fund. As I said, very conservative. And, you know, ‘no surprises’ is very much the mantra of our of our investment approach there. And then the third fund in the stable is the eInvest Income Maximizer fund. And the code there is EMAX. And what we do there, it’s really just about extending what we do in core income and taking a little bit more risk, moving down into a little bit lower credit ratings, although still investment grade and really, you know, take taking our investment approach the next level to generate a return of bank bill of the cash rate, I should say, plus three percent to four percent per annum. And that’s really just taking, as I said, taking the approach that we use and extending it, but investing in very similar types of assets.

 

And how often did the distributions happen?

 

Yes, monthly distributions. It’s been, you know, is very much a part of the design feedback that we got from investors. But they really valued that sort of monthly distribution. And the way that our portfolios are structured is very diversified. So we’ve got lots of bonds paying coupons all the time.

 

So, we’ve got lots of cash there to pay regular distributions on a monthly basis. Where can listeners find more information about these funds?

 

Yeah, absolutely. So, it’s really easy. Einvest.com.au/asa. We’re going to summarize all of the key points we’ve talked about on the podcast here today. And of course, the other podcast itself will be available to relisten, too, as well. So, yes, very, very easy. And then from there, you can obviously go into the broader eInvest website where we’ve got much more information on all three of the funds.

 

Brad, thanks very much for joining us on the podcast today. Thanks very much.

 

The company and your guest has contributed to the costs associated with producing this episode of the Equity Investor Journey. Important. Please remember, these podcasts are produced to provide information and education, and they are not designed to provide financial advice, nor are they recommendations to buy shares in the companies featured. The Australian Shareholders Association does not endorse or favour any specific commercial product or company. Please obtain independent professional advice before investing. We value your feedback and questions. Please contact us at [email protected] If you have any suggestions for guests or specific questions you’d like answered.