A continuation of an interview with Jamieson Coote Bonds’ Charles Jamieson – visit here for Part 1.
Tell me what your thoughts are on the current market, is this an opportunity to buy in? Will rates go higher from here? How do you feel about inflation?
Good timing Liz, I’ve only just finished a 13,000 word paper on inflation.
While we could talk all day, I’ll just give you the elevator pitch.
Inflation must move higher mechanically. Because last year, growth plummeted as did the oil price, it was tremendously deflationary. A year on, we’re dropping all of that negative data out of the inflation calculation. So, the rate of change moves to be hugely positive. As time progresses, inflation flattens out, you don’t get the big positive swings, but rather data that is similar. Then it starts to fall away thereafter.
I don’t expect we’ve seen the end of volatility in the bond markets. It sells off at the long end of the curve first, which impacts total returns, then intermediate 5-10 years and things can bounce around in there but generally yields are reset. Then right at the end, it sells off in the front end.
Everything is happening now due to expectations but if they do continue to play out all the way down to interest rate hikes then it crushes future inflation expectations and flattens the curve. Total return is actually really good in bonds.
There is a point when we crest this inflation hill and we’re still getting up to that point. We expect it to happen around about the middle of the year, where thereafter the market looks really investable.
We’re talking now to advisors about setting up portfolios to make the allocations when the timing is right. Yields have been re-established and the steepness of the government bond yield curve is extraordinary compared to prior episodes.
Looking at the benchmark 3-10 year government bond curve, it’s as steep as it has been since 1992. It makes my environment a lot easier. If you get a roll and carry environment, that alone can be incredibly powerful.
The market is really very yieldy versus cash rates. Then that’s a very good go forward environment. The naysayers would say the RBA has to raise rates, but really, how much scope is there really available to achieve that, and how much escape velocity can there be in those economies and will they be able to hold up?
For example, property is moving pretty fast. How would it go under higher interest rate settings?
Until we get back to that much longer term trend to talk about secular inflation, we believe everything is very transitory. The base affect will come and go and supply blockages will come and go with lots of spare capacity in the economy. Things seem to clear quickly if there is spare capacity and the cost of capital is still low. It a bit like the Suez Canal, once it clears it just flows freely.
Reflation, that is coming back from a deflationary period, is really getting confused with inflation and for there to be inflation we really need wage growth or an oil shock or a war.
Haven’t pandemics been inflationary as well?
Sure, in the short term but in the long term it’s questionable. There are huge amounts of slack around. I think you’ll find the news flow here will go quickly from boom and Gatsby-esque to job layoffs, the end of Job Keeper, people getting retrenched.
I do think in terms of COVID and your own circumstances up in Queensland, particularly in the Southern states as winter arrives, we’re going to get more stop/start economic outcomes and that makes it really hard to plan. It’s a long way until we get back to 2019 economics. We’ve come a long way off the bottom, but the economy is going to be challenged. It’s hard to get a good read on major trends because data is patchy and has been volatile.
For example, you go into lockdown, everything collapses. Then the economy opens up and everyone wants to go out to dinner and it all flies again.
Global markets have enjoyed the pandemic to a degree, with all the stimulus. The irony is that it’s actually the recovery itself that can be quite problematic.
It’s that constant policy accommodation and then the emergency settings are dialled back.
What we’ve seen is that some clients are pretty underweight in bonds. Certainly, in March and April last year when everything else was melting, bonds did a really good job for people. They were liquid, traded at a premium when a lot of other assets were trading at a discount.
We had clients that sadly said goodbye to us and that’s how it should be done, but they are now wanting to invest again as they’ve done very well with equities and want to reset their defensive assets.
Compensation is now a whole lot better than it has been and the curves are steep.
People are asking how they go about investing, when they start to move. Broadly, it’s the middle to the back part of this year. We’ll be interested to buy longer dated bonds at that time assuming we get those higher inflation prints. You can get chaotic moves that then snap back, it’s as quick as that, it’s a crescendo moment.
Markets are just moving so fast. The reality is, many investors can’t move at that pace and need to get set up for the episodes and be strategic well ahead of time. So, when it plays out you have a strategy that considers the outcomes.
So, are you holding firepower for that time?
Yes definitely, we’re thinking about that at the moment. As an index relative manager our job is to own the asset class through thick and thin. Ideally, we hold less when it’s decaying and a bit more when it’s going to perform.
There’s a lot of water to go under the bridge between now and then. And assuming you’re wanting to build a portfolio for retirement or re-establishing a defensive allocation then that’s the time, assuming we don’t go into a secular long run inflationary environment. But if we do go into that, everything gets destroyed and probably a lot more than bonds would get hurt.
It would be shocking for all riskier asset valuations.
Interest rates are the virus that infects all things – they are our funding rates and our discount rates. People don’t get the reason they’ve done so well in property is essentially because they have been long duration credit in a 30 year bond bull market.
You might remember when mortgage interest rates were 17%, people couldn’t borrow much because they couldn’t afford the repayments. Now, Westpac will lend 1.89% fixed for four years. People can borrow $1 million dollars and it costs just $18,000 a year to service it if you have a reasonable job.
It’s an extraordinary time. The capital valuation of everything has gone through the roof because the servicing costs have become so low.
In reverse, it’s so much faster because you get people that are forcibly de-levered. Politically, the government doesn’t want to do that, so it’s very unlikely were going to go through that because the whole system starts to collapse in on itself.
The corporate bond market, known as ‘credit’ can be the first market to ‘snap’ if companies can’t get refinancing for maturing debt then everything starts to come to a halt and it can be brutal. It’s tremendously problematic.
The lesson for a lot of people last year was in the unit fund market where government and corporate bonds were held together. They found the entire structure got compromised because once the credit market froze, managers needed to raise material buy/sell spreads in order to protect existing investors and be truly representative across the combined spectrum.
So that was different for us, we didn’t need to do that. But it was a stark reminder of liquidity and how problematic it is if you don’t have it.
It’s such an uneven recovery. Some asset classes have gone through the roof.
Can you tell us a little about your funds, what you want to achieve for investors and what has the performance been like?
We run three funds.
We started with our flagship, domestic only, government or government guaranteed bond fund. It includes state government bonds and supranationals. In AUD only, index relative we believe the index or beta is highly investable. That didn’t happen in March, but over time is incredibly powerful.
We exist to take clients through that journey and optimise that outcome. We’ve been a very consistent alpha generator in providing excess return and have generally done that on lower market risk as well.
We then launched a global version of that fund, so that’s indexed off the G7 – US, Canada, Japan, UK, Italy, France and Germany and we split that into two – one sleeve is run in USD and the other hedged back to Australian dollars. The USD fund is a very powerful negatively correlated fund when the US dollar is doing well.
In the first three months of 2020, that unhedged fund was up 24%. Then in the following nine months, and markets settled, it gave it all back. But at the crucial time, right when you needed it, the fund delivered. Investors didn’t need a lot in their portfolios to balance out quite a risky equity portfolio.
Most recently we’ve had demand for lower duration and launched an absolute return fund called the Dynamic Alpha Fund. It’s in the same universe in domestic and international government bond markets. It’s very liquid and trying to drive low total return outcomes on very low volatility. We’ve gone to market on that as RBA cash +250 basis points net of fees. Last year that fund achieved a bit more than 5% on a 2% volatility, which is really good. There’s a lot of demand for the product. It’s great for people that did use cash and are comfortable with low return.
Some investors are using it as a stand-alone investment. It comes with different volatility and performance objectives to the other funds.
So, we think we have something for everybody now. We want to optimise the environment for different types of clients. We manage funds for large institutional superannuation funds all the way through to mums and dads.
There are going to be periods where high grade government bonds are not attractive and periods where they’re much more attractive and broadly we are getting to the later as the market resets.
Lastly, what do you do to relax?
I’m married with three kids and spend most of my time chasing them around. To be honest there are times I come to work to have a break!
I love relaxing with friends with a BBQ and playing sports in the backyard or getting out and about, chasing the dog around.
We have a more traditional family background.
Do you have any plans to travel?
I’m not sure if you are aware, we have a Singapore office and we did travel up there a bit. We’ve lived overseas and like to travel but it’s going to be problematic for a little while yet. So, no real plans, maybe a few road trips.
Main image: Charles Jamieson (right) pictured with his business partner, Angus Coote.