- Wider credit spreads and higher bond yields detracted from performance, as did hedges that we have entered due to our medium-term bearish view of markets
- When the current period of market volatility settles, the portfolio will feature a much higher yield will benefit investors over time
|Month (%)||Quarter (%)||1 Year (%)||Since Inception* (% p.a.)|
|RBA Cash Rate||0.01||0.02||0.10||0.16|
^ Inception date for DHOF was 1 March 2020. Excess return is measured with reference to net performance. Returns for periods longer than one year are annualised. Past performance is not a reliable indicator of future performance.
DHOF Fund and Investment Objective
DHOF targets an absolute return over time by investing in a diversified portfolio of hybrid securities which offer the best risk adjusted returns available from a global universe of securities.
The aim of DHOF is to provide a steady stream of income over the medium term, by investing in a diversified portfolio fo Australian and global hybrid securities and cash, and to provide a total return (after fees) that exceeds the Benchmark by 3.5%-4.5% measured throughout a market cycle.
- Modified duration: 1.42 years
- Spread duration: 3.32 years
- Running Yield: 3.80%
- Average Credit Quality: BBB
- Portfolio ESG Score: A
- Management Cost: 0.65% + 0.10% pa expense recovery (incl. of GST and RITC)
- Inception Date: 1 March 2020
The Fund delivered a negative return of 2.26% for the month with the biggest detractor being holdings in European bank hybrids. This volatility spread to all holdings in the early part of March, before stabilising later in the month. Performance of other fund holdings was very diverse with no consistent themes between Australian and non-European offshore holdings. Another detractor from performance was the steps taken to reduce market exposure, specifically the timing of those trades. One of those measures was increasing cash holdings which will lay the foundation to capitalise on opportunities into the future, while direct hedges did not have the desired effect. The issuers in our portfolio have largely “returned to scale” in recent months, as pandemic-era loss provisioning has reverted to normal levels and profitability has returned to at-or-near the cost of capital. Looking forward, we see challenges brewing for revenue and earnings growth (due to rapidly flattening yield curves) and asset quality (due to consumer price inflation). We are already assessing banks’ preparedness to address these issues.
The range of possible outcomes and their attendant probabilities remain numerous and fluid, respectively. With that healthy dose of caution recorded up front, we expect three key, interconnected trends to permeate and influence economic and financial markets in the coming months – inflation, commodity prices, and geopolitics.
Central banks worldwide have been responding to inflationary pressures for months, and with the US Federal Reserve joining the chorus in March, we expect the trajectory to accelerate through 2022. Even Australia, who just six months ago was still forecasting “lift-off” in late 2023/early 2024, could now increase rates as early as June 2022. We do not subscribe to this view, based on the RBA’s insistence on observing sustainable wage increases above three percent before moving. As at time of writing, the earliest we could see multiple quarters with the required growth rate would be September/October of 2022.
In one sense, the normalisation of rates is a positive signal because employment globally has held up far better than expected. Nevertheless, the whole raison d’etre of higher interest rates is to encourage saving and moderate economic activity to manage inflationary impulses. One of the challenges the globe faces is that households already have elevated savings as a response to pandemic era support measures, elevated uncertainty, and truncated consumption patterns. Rising interest rates will also have a more direct impact on property markets, such as in the United States where the cost of the popular 30-year fixed mortgage rate has jumped quickly in 2022. Rising funding costs for Australian banks will create an additional driver of rising mortgage rates, although after heady gains during 2021 some moderation in housing markets would not be a bad thing, in our view.
Arguably the most prominent driver of rising inflation expectations is commodity prices. This moniker covers a broad range of materials ranging from energy to fertiliser to wheat. The immediate focus of attention is the energy complex, where demand remains strong, but supply concerns persist. An already tight market is being pressured by harsh sanctions on Russian production, exacerbated by voluntary withdrawal of trade by private entities wary of violating the broad range of restrictions. As a result, prices are biased strongly to the upside and show no sign of receding as the world scrambles to secure alternate sources of supply. Reliable energy exporters such as Australia are beneficiaries, including the local currency, but ultimately cost increases will filter into transport and electricity costs and will ripple through entire economies.
Markets attempt to discount all known information into current prices but assessing the implications of war is especially difficult. With Russia being a large energy exporter, the first order impacts are clear. But with Ukraine (and to a lesser extent Russia) being a significant exporter of foodstuffs including wheat and corn, major disruptions to agricultural production could have direct, real-world effects on products that everyone consumes. For those with a longer memory, persistent food inflation is acknowledged as one of the triggers for the Arab Spring of 2011. As a result, we remain wary of exogenous shocks arising from the fog of war.
Financial markets have been expressing their views on key thematics via yield curves, credit spreads and equity prices, with some curious disparities. The short end of yield curves have been pricing in more aggressive hiking cycles despite geopolitical uncertainties, with the belief that central banks must respond to inflationary pressures or risk the even more dire outcome of a stagflationary spiral. This is not our base case but would be the worst case for both economies and markets. However, the long end has not responded in the same way, leading to a raft of yield curve inversions the likes of which we last observed in 2018. We believe this can be explained partly by a flight-to-safety trade based on the risk of a prolonged conflict in Ukraine, but also by the market hedging against the risk that a swift hiking cycle creates an economic downturn that forces central banks to pause or reverse course either next year or in 2024. The big unknown remains the outlook for quantitative tightening (QT), a likely long and drawn-out process that has little to no historical precedent but could just as easily derail even the most well telegraphed interest rate normalisation cycle.
Risk assets have had a rocky start to 2022, but credit markets have generally been more sanguine than equities. Credit spreads have widened modestly but persistently since late 2021, while equities have fluctuated wildly. We have noted a clear fall in market volumes in both equity and fixed income, with this reduced liquidity contributing to wider daily movements. This may simply reflect some anticipation of the impending commencement of QT, creating the potential for further volatility as the actual process begins. Therefore, against a backdrop of uncertainty, we remain positioned for flexibility. Yield curves have begun to invert, but they are by no means a perfect predictor of recession. Commodity prices will be supporting an inflationary impulse for the foreseeable future, especially while hostilities continue in Ukraine. Without clear positive catalysts, our base case is for yields and credit spreads to continue moving wider in the months ahead.
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Past performance is not a reliable indicator of future performance. Please read the PDS prior to investing. This information is general in nature and is subject to the terms and conditions outlined here.