Where Should Investors Find Income in Fixed-Income?

As many investors today are moving to protect against downside risk and meet fiduciary obligations by derisking, they continue to seek income and return, according to a recently published study by Wellington Management.

(June 27, 2012) — With yields on high-quality bonds yielding low interest, it’s hard to find income in fixed-income, says Lori Whiting, investment director at Wallington Management.

“One solution is a diversified multisector credit portfolio, with a focus on higher-yielding credit sectors and securities whose mix shifts with changes in market conditions,” she advises in a newly released whitepaper. She notes that this approach to credit can help meet the desire for income while retaining the downside protection a fixed-income portfolio can provide.

According to Whiting, across credit sectors, some of the best opportunities for investors are in high yield, bank loans, and non-agency residential mortgage-backed securities (RMBS).

Nevertheless, exploiting the income and return potential of credit sectors does not come without risk. “By definition, investment in these sectors entails credit risk; a significant portion of the opportunity set is rated below investment grade. Furthermore, securities in these sectors are often callable, so the higher income and yields they offer could be cut short if falling yields lead obligors to buy back their high-coupon debt,” the paper asserts.

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The low yield among bonds is a familiar story. Last year, research by the London Business School and Credit Suisse noted that bond investors should expect less robust returns in the future. London Business School’s Elroy Dimson commented: “We are struck by the volatility of the size, value and momentum effects. Over the long term, all three factors have provided a positive risk premium. But over shorter intervals, these premia can easily go into reverse.”

The authors of Credit Suisse’s report found that bond investors should not expect returns for the next 11 years to be as strong as those of the previous 11 years, largely as a result of rising inflation. While bonds in 19 developed markets worldwide outperformed stocks in the 11-year period ending December 21, 2010 by an average annualized 3.2 percentage points, the outperformance of stocks over bonds in the same countries has been by 3.8 percentage points since 1900.

Canadian pension funds will increasingly look to Australia for long-term infrastructure and investment opportunities, according to an industry panel hosted by The Trust Company.

(June 27, 2012) — Canadian pension funds are increasingly seeking long-term infrastructure investments in Australia, according to a panel hosted by The Trust Company (TTC).

Canadian investment in Australian property and infrastructure has ballooned in recent years, with Australia now the third largest global destination for Canadian direct investment abroad (excluding tax havens), according to the TTC, a trustee company that offers services including infrastructure custody. Canadian direct investment in Australia is approximately C$25 billion, making the two-way investment between both Australia and Canada around C$45 billion.

“Canadian investors are looking for stable returns in the current low-yield environment and are showing a strong interest in Australia given its proximity to Asian markets and, in particular, China,” said Andrew Cannane, general manager of corporate clients at TTC. “On a relative risk weighting Australia is still a most attractive investment destination for investors; it is highly transparent, it has legal certainty, and a 4.3% GDP growth.”

The panel featuring Scott Farrell and Matthew Stutsel, partners at KPMG; Komu Kumar, investment director of financial services at Austrade Canada; and Andrew Cannane, general manager of corporate clients at The Trust Company, looked at opportunities presented by the wave of Canadian investment into Australian infrastructure and property.

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Meanwhile, earlier this year, the Canada Pension Plan Investment Board, which manages about C$155 billion, told Bloomberg that it plans to increase its longer-dated investments in Australia to boost returns. “We would like to grow CPPIB’s presence here,” the Canadian fund’s Chief Executive Officer David Denison told the Canadian Australian Chamber of Commerce in Sydney, according to an e-mailed copy of his speech. In April, OMERS announced the start of a Global Strategic Investment Alliance (GSIA) alongside initial alliance members Pension Fund Association (PFA) and a consortium led by Mitsubishi Corporation (MC), both of Japan.

The sentiments about Australian infrastructure and property investments also follow efforts last year among Canadian funds to form a global alliance of infrastructure investors that would help pensions further build up its portfolios. In March of last year, the Ontario Municipal Employees’ Retirement System (OMERS) proposed the alliance at a pension conference in the United Kingdom. Infrastructure – a common investment for large pension funds due to their steady cash returns – has been a staple of OMERS’ portfolio for years through its Borealis subsidiary, but is gaining momentum elsewhere as funds grow in size and are thus able to allocate more capital to these often illiquid investments.

Related article: Infrastructure—or Imprudent?