MLC Portfolio Manager Nicholas Hofmeyr speaks to MLC Research Manager Rebecca Collins about the record low interest rate environment and why active management in fixed income portfolios is important.
Rebecca Collins: I'm Rebecca Collins, research manager for MLC, and today I'm joined by Nick Hofmeyr, portfolio manager for our fixed income portfolio. Thanks for your time today, Nick.
Nicholas Hofmeyr: Thanks, Bec. Good to be here.
Rebecca Collins: Passive investing is one of these areas that gets a lot of market coverage. There's a couple of areas investors should think about though. It obviously lowers the cost of your overall but what else should investors be considering before making a decision between active and passive?
Nicholas Hofmeyr: Well generally fixed income plays two major roles in a diversified fund. It provides an income through the coupons you receive the bonds, and it also provides some protection because bonds are safe investments and they tend to do well when equities are delivering negative returns.
The problem with the current environment is that interest rates are very low so you're not really receiving that income component that you were before. The other issue is the duration, which is a kind of sensitivity to interest rates, is very high. Now with duration when interest rates rise, your fixed income portfolios tend to fall, right? And the longer your duration, the more that your fixed income portfolio is going to fall.
We have the starting point at the moment with the major fixed income benchmarks where you've got low income and a lot of interest rate sensitivity. Bringing that back to passive investing, because they basically have to follow the index exactly, they have exactly the same problem. Very low income and very high sensitivity to interest rate risk. So if interest rates started to rise, they could end with some significantly negative returns and that's really not what you're looking for in your fixed income allocation.
Rebecca Collins: Thanks Nick. And what about the level of debt with each country that's a part of the index that makes up the fixed income universe?
Nicholas Hofmeyr: Yeah, that's another characteristic of fixed income benchmarks is the constituents tend to be weighted towards those companies and countries which have issued the most debt, taken on the most debt. And what that means is you have your biggest exposure to the riskiest countries and companies because obviously all else equal the more debt you have taken on the more riskier your company is.
Again, this is where we think active management is really crucial because it allows us to avoid those companies and countries that are the most risky if we have some concerns that they might not be able to repay their debt.
Rebecca Collins: Thanks Nick. How do MLC manage fixed income portfolios for our clients?
Nicholas Hofmeyr: We at MLC user a multi-manager approach which means that we try to find a range of managers with different skills and approaches, and we combine them into a well-diversified and balanced portfolio. The other aspect of fixed income markets is that they're incredibly broad and varied, and it's difficult to find one manager who can do everything across that whole space well so we tend to find specialists in each place. We have, for example, a global government bond specialist and we have some global corporate bond specialists.
The other way that that helps is we've got our experts in each area, but it also means that you don't build up any unintended concentration in your portfolio so it can help with risk management by keeping a portfolio well balanced and diversified.
Rebecca Collins: Thanks Nick. So there's a few factors to consider aside from just the price you're paying when it comes to the fixed income universe.
Nicholas Hofmeyr: Absolutely.
Rebecca Collins: Great. Thanks for time today, Nick.
Nicholas Hofmeyr: It's a pleasure.
Rebecca Collins: And thank you for joining us.