Australian Bonds prices at record highs

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by Clive Tompkins

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Transcription of Finance News Network Interview with Antares Fixed Income Investment Manager, Ken Hyman

Clive Tompkins: Hello Clive Tompkins reporting for the Finance News Network. Joining me to discuss the interest rate environment and historically low Government bond yields is Antares Fixed Income Investment Manager, Ken Hyman. Ken welcome to FNN.

Ken Hyman: Hi Clive.

Clive Tompkins: First up. Can you introduce Antares Fixed Income for those in our audience who have not heard of you before?

Ken Hyman: Antares Fixed Income is a specialist fixed income manager; we’ve been managing fixed interest and cash since 1992. We started off with about three billion under management and a team of five; we have currently over 17 billion under management and a team of nine. Our traditional clients are large institutional investors and that’s most probably the reason for our low market profile.

Clive Tompkins: Thanks Ken. Now the world is one of much lower interest rates than seen for several decades. As a manager with 40 years’ experience in debt markets, does this suggest a bubble, or is this the new norm?

Ken Hyman: Well Clive, there’s no doubt it’s unprecedented times for me and I invested through the 1970’s. Bond yields in the large markets such as the US, Japan, Germany are below 1.5 per cent at the moment for 10 year bonds. In the US and Japan, these yields have been brought down to those levels by very, very aggressive buying by their central banks as part of their quantitative easing process. This has produced what we call financial repression, which is bond yields trade down to a level that produces a sub-economic return for the investors.
Now, real money investors such as Antares are forced to accept these very low bond yields. I just want to explain the real yields currently available; the real yield is the yield over and above the rate of inflation. At the moment with an Australian 10 year bond at 275 and inflation at 250, the real yield is a quarter per cent. That isn’t a yield that is going to help you either grow your capital, or even maintain the purchasing power of your capital.
So are we in a bubble or this the new norm? Well if we move into a global recession where inflation moves down to about zero per cent, that could be the new norm and in that case, the real yields would be about 2.5 per cent. Alternatively, if inflation doesn’t fall away and maintains its current levels, we’d say it’s a bubble if it’s only producing a real yield of about a quarter per cent.

Clive Tompkins: And Ken, what about Australian Government bonds which are now at an all-time record low, in terms of yield?

Ken Hyman: Well Australian bonds are enjoying their safe haven status. Global investors are in love with our triple-A rating and with the - what I call, a buyers strike in sovereign bonds in Europe. There’s pent up demand for global investors to acquire safe sovereign bonds. Now, we believe our safe haven status is predicated on China and China maintaining reasonable growth. They have to engineer a soft landing. However, if that weren’t to come about and we moved into a global recession, then we believe that we could lose our safe haven status very quickly.

Clive Tompkins: Thanks Ken. And could yields fall further and if so, by how much?

Ken Hyman: As I’ve mentioned, I think our fortunes are very much driven by China and the ability of China to engineer a soft landing. In the event of a soft landing, we think that we will maintain our safe haven status and that our bond yields will most probably track the fortunes of the US bond yields. Now we see US bond yields most probably moving up to 50 basis points lower, close to one per cent and in the process, we could see Australian 10 year bonds moving down to around 2.5 per cent.

Clive Tompkins: And what are the risks of a move out of Aussie dollar assets?

Ken Hyman: Well we must remember that Australia is a large debtor country with gross foreign debt of about 130 per cent of GDP. This is predominantly household debt, that’s been intermediated through the banks. Now history has shown that debtor countries do not fare well during a recession. And in a global recession, we think that there would be a drain of foreign capital and foreign funding out of the Australian market. If we look back to 1990, the Asian crisis in ‘97, the tech wreck in ‘01/’02, GFC in ‘08/’09 - during those recessions there was a rapid exit of foreign money from our bond markets, which triggered substantial sell-off in our bonds.
Now we believe in a hard landing where - or a global recession that foreign money will exit in a hurry. As we say, the Dear John letter arrives by Twitter these days - it’s quick, it’s instantaneous. And we envisage that in that environment, Aussie bond yields could rise over 200 basis points. Our current spread over the US is about 130; we would say in that adverse environment, we could see that spread widening to something like 300 basis points.

Clive Tompkins: And Ken, several years ago the Australian Government bond market was contracting as the Federal Government ran surpluses. What is the size of the Government bond market today?

Ken Hyman: It’s currently about 220 billion; this compares with 60 billion back in 2007 before the GFC. This increase has been driven particularly
by the budget deficits the Government has run since the GFC.

Clive Tompkins: And is it growing today and if so, by how much?

Ken Hyman: Over the last three years that issuance has been running at about 55 billion per annum. It’s forecast to increase by about 40 billion over the next year. However, that’s predicated on reasonable growth of three per cent or so that we saw in the Budget.

Clive Tompkins: And what is their commitment to continued issuance?

Ken Hyman: The Government has committed themselves to maintaining a liquid Commonwealth bond market, which we in the market warmly endorse. They’ve mentioned a range of 12 to 14 per cent of GDP as a targeted range. That equates to about 150 - to about 200 billion.

Clive Tompkins: Thanks Ken. Now what is the profile of clients that invest in your Fixed Income Funds?

Ken Hyman: Yes, they’re investors who are looking at fixed income as a diversified investment to produce good returns in an environment where growth assets such as equities, are underperforming. Of late we’ve been seeing more investors who are targeting income streams, secure and with liquidity as well.

Clive Tompkins: And how has your key Fund performed both in absolute and relative terms?

Ken Hyman: Our Fund has performed pretty well over the recent past. We came through the GFC pretty well; we do take a defensive approach to credit. Our credit exposures avoid the blow-ups during adverse environments, market environments. Over the last three years, we’ve done particularly well; we’ve been able to come through the European sovereign debt crisis very much intact. Our Fund has returned 7.7 per cent per annum for those three years, versus a benchmark return of 7.1 per cent, the benchmark being the UBS Composite Bond Index All Maturities. And this return is value add of 60 basis points versus the benchmark, has placed us in the first and second quartile versus our competitors in that universe.

Clive Tompkins: Last question Ken. These are certainly interesting times with Government bond yields at record lows in many parts of the world. What do you think the situation will be 12 months from now?

Ken Hyman: Well my hope is that we muddle through with a soft landing in China, our subdued inflation and current low bond yields are maintained, and that possibly even move a little bit lower. However, there are two adverse scenarios. There’s the scenario of a global recession and an uplift in inflation. In both those scenarios, we think that Australian bond yields will rise appreciably. We think that there’s scope for bond yields to move down 50 basis points at the maximum. But in the adverse scenarios, we think that yields could rise upwards of 200 basis points. So we see that the risk return is very asymmetrical - a small gain that could be offset by maybe some substantial losses.

Clive Tompkins: Ken Hyman, thanks for the update.

Ken Hyman: It’s a pleasure Clive.

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