FIIG - The Fixed Income Experts

News and Education

Is your managed fund hiding something?

by Elizabeth Moran | Sep 09, 2014

Two recent events brought home how powerless investors in managed funds are when danger looms in the financial markets.

First, an advisor client sent me an email expressing a range of concerns about the bond market including the risk of a meltdown in emerging market bonds caused by Argentina, signs of stress on the high yield bond market and an alert he’d been sent by a fund manager that it was increasing cash holdings due to its concerns about a potential credit event. 

Argentina, in case you missed it, defaulted on some of its debt payments recently which as a consequence sent the prices of emerging market bonds and shares lower. Fortunately, the event had no impact on the domestic bond or share markets. However, a managed fund investor will not know what impact it had on their investment because they will not know if the managed fund owns Argentinean bonds or shares. 

The stress on the high yield bond market the advisor was referring to was in relation to US dollar bonds. The US high yield market makes up over 20 per cent of the whole US corporate bond market.

Incidentally, the stress in the US high yield market has not spilled over into Australia. We haven’t in see any “stress” on any of the high yield bonds we trade. Interest rates must rise or the credit quality decline and potential for default rise for high yield bonds in the domestic market to be significantly impacted.

Rising interest rates will impact all asset classes but the big question remains, when? In the meantime current high yield bond issues soldier on towards maturity reducing terms and the impact on any rate rises.

It also turned out that the fund manager note received by the advisor referred to its managed equity funds not its bond funds. The note explained they were moving from a 5 per cent cash holding and increasing it to 10 per cent to reduce risk.

Like other managed funds, the equity fund only discloses the top 10 holdings. In this particular AUD global equity fund these top 10 holdings made up around 50 per cent of the portfolio, although the fund also disclosed a 19 per cent exposure to emerging markets and 20 per cent to the rest of the world.

Here’s the crux, investors don’t know what’s in the rest of the portfolio, so how can they assess the potential risk of say, a default by Argentina or any other event?

I’d be fairly happy if I had invested in global equity funds that are taking some of the risk off the table and increasing their weighting to cash. This will help them fund redemptions and help insulate the funds from losses if a much talked about correction eventuates.

But the advisor’s experience illustrates the central problem of managed funds: they have none of the certainty of direct investment. If there’s a big correction these funds could be frozen or wound up and investors could lose money.

Interestingly, the questions from the advisor coincided with a second event which illustrated problems with managed fund investing. In mid-August four of the van Eyk Blueprint series managed funds were wound up because of a “mysterious $31m illiquid investment”. The news sent investors rushing to redeem van Eyk funds and this week the first steps were taken to wind up nine of the remaining ten funds.

Investing direct and understanding the risks will help protect your capital. Direct investment in Australian dollar investment grade bonds is a much lower risk strategy than managed funds that do not disclose all investments.

Copyright The contents of this document are copyright. Other than under the Copyright Act 1968 (Cth), no part of it may be reproduced or distributed to a third party without FIIG’s prior written permission other than to the recipient’s accountants, tax advisors and lawyers for the purpose of the recipient obtaining advice prior to making any investment decision. FIIG asserts all of its intellectual property rights in relation to this document and reserves its rights to prosecute for breaches of those rights.

Disclaimer Certain statements contained in the information may be statements of future expectations and other forward-looking statements. These statements involve subjective judgement and analysis and may be based on third party sources and are subject to significant known and unknown uncertainties, risks and contingencies outside the control of the company which may cause actual results to vary materially from those expressed or implied by these forward looking statements. Forward-looking statements contained in the information regarding past trends or activities should not be taken as a representation that such trends or activities will continue in the future. You should not place undue reliance on forward-looking statements, which speak only as of the date of this report. Opinions expressed are present opinions only and are subject to change without further notice.

No representation or warranty is given as to the accuracy or completeness of the information contained herein. There is no obligation to update, modify or amend the information or to otherwise notify the recipient if information, opinion, projection, forward-looking statement, forecast or estimate set forth herein, changes or subsequently becomes inaccurate.

FIIG shall not have any liability, contingent or otherwise, to any user of the information or to third parties, or any responsibility whatsoever, for the correctness, quality, accuracy, timeliness, pricing, reliability, performance or completeness of the information. In no event will FIIG be liable for any special, indirect, incidental or consequential damages which may be incurred or experienced on account of the user using information even if it has been advised of the possibility of such damages.

FIIG provides general financial product advice only. As a result, this document, and any information or advice, has been provided by FIIG without taking account of your objectives, financial situation and needs. Because of this, you should, before acting on any advice from FIIG, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If this document, or any advice, relates to the acquisition, or possible acquisition, of a particular financial product, you should obtain a product disclosure statement relating to the product and consider the statement before making any decision about whether to acquire the product. Neither FIIG, nor any of its directors, authorised representatives, employees, or agents, makes any representation or warranty as to the reliability, accuracy, or completeness, of this document or any advice. Nor do they accept any liability or responsibility arising in any way (including negligence) for errors in, or omissions from, this document or advice. Any reference to credit ratings of companies, entities or financial products must only be relied upon by a ‘wholesale client’ as that term is defined in section 761G of the Corporations Act 2001 (Cth). FIIG strongly recommends that you seek independent accounting, financial, taxation, and legal advice, tailored to your specific objectives, financial situation or needs, prior to making any investment decision. FIIG does not make a market in the securities or products that may be referred to in this document. A copy of FIIG’s current Financial Services Guide is available at www.fiig.com.au/fsg.

An investment in notes or corporate bonds should not be compared to a bank deposit. Notes and corporate bonds have a greater risk of loss of some or all of an investor’s capital when compared to bank deposits. Past performance of any product described on any communication from FIIG is not a reliable indication of future performance. Forecasts contained in this document are predictive in character and based on assumptions such as a 2.5% p.a. assumed rate of inflation, foreign exchange rates or forward interest rate curves generally available at the time and no reliance should be placed on the accuracy of any forecast information. The actual results may differ substantially from the forecasts and are subject to change without further notice. FIIG is not licensed to provide foreign exchange hedging or deal in foreign exchange contracts services. The information in this document is strictly confidential. If you are not the intended recipient of the information contained in this document, you may not disclose or use the information in any way. No liability is accepted for any unauthorised use of the information contained in this document. FIIG is the owner of the copyright material in this document unless otherwise specified.

The FIIG research analyst certifies that any views expressed in this document accurately reflect their views about the companies and financial products referred to in this document and that their remuneration is not directly or indirectly related to the views of the research analyst. This document is not available for distribution outside Australia and New Zealand and may not be passed on to any third party without the prior written consent of FIIG. FIIG, its directors and employees and related parties may have an interest in the company and any securities issued by the company and earn fees or revenue in relation to dealing in those securities.