FIIG breaks new ground

When FIIG brought its Managed Income Portfolio Service (MIPS) to market early last year it broke new ground and Lonsec’s analysis suggests there are good reasons why some investors will find the product an attractive vehicle for those looking at fixed interest investing. 

According to the most recent statistics provided by the Australian Bureau of Statistics (ABS), the level of exposure to domestic fixed income securities was at approximately 11 per cent, following a steady decline over the past 20 years. This coincided with an increase in both equities and cash. According to the ATO as at June 2017, over 23 per cent of self-managed superannuation fund (SMSF) money was still sitting in cash and term deposits and only one per cent in direct debt securities.  

There have been many reports over recent years with theories about why this has been the case. These have included the historically low performance and the relative underdevelopment of our corporate bond markets, a greater degree of comfort with equities given their stable dividend and franking credits, the perceived lack of depth and liquidity of the Australian market, and a lack of product offering and a general lack of education and knowledge on fixed income securities. It is our opinion that all of these considerations hold true to a certain degree.  

Fixed interest has often been the most misunderstood portion of a client’s portfolio. A critical element of investing, and advice, is ensuring that the investor (and adviser) has complete confidence in what they are investing in, and understands the characteristics of the investment, its return profile, and risk. However, more importantly, investors must understand the role the investment plays in the total portfolio. 

For most investors, the objective of the fixed interest portfolio is two-fold. The first is to act as a diversifier to equities – the asset class that will not go down when equities fall and also not have the volatility of equities. The second objective, often stated especially for retirees, is the need for steady income.  

Unfortunately for most investors, as yields have fallen around the globe, the income objective has become increasingly difficult to achieve without ratcheting up the risk of the portfolio. At the same time, bond prices have also risen sharply, leading to concerns around valuations.  

This has raised concerns as to the type of strategies and structures available for investors who still require an allocation to fixed interest securities in their portfolio. In light of this, the one area that we have seen a significant improvement in over the past few years is the accessibility of various solutions within the fixed interest realm to ensure that exposure to fixed interest not only grows but becomes more aligned to the client’s objectives and needs.    

[[{"fid":"32200","view_mode":"default","fields":{"format":"default","field_file_image_alt_text[und][0][value]":"","field_file_image_title_text[und][0][value]":""},"type":"media","attributes":{"style":"height: 229px; width: 700px;","class":"media-element file-default"}}]]

In a release by the Australian Government in October 2015 as part of the Financial System Inquiry, it was acknowledged that as the Australian bond market is largely over-the-counter with many corporate bonds requiring minimum $500,000 investments, as well as lacking transparency in comparison to other countries such as the US, retail investors were effectively precluded from investing directly in these bonds.  

Looking to rectify this, the Government recently undertook a number of initiatives, with the most relevant being that the Government has made exchange-traded Commonwealth Government Bonds (CGB) available for trading on the Australian Securities Exchange (ASX).

Since May 2013 the listed CGBs have not only enabled a visible pricing benchmark for government bonds but have also provided a form of encouragement for retail investors to consider diversifying their portfolios into fixed income securities. However, because CGBs are the lowest risk (in terms of credit) bonds on offer by an Australian issuer, the yields are also quite low at present – very close to cash rates, making it very difficult to make the case for bond ownership. 

However, problems still remain with many of the smaller corporates with many issues not able to disclose credit ratings to retail investors, and thus providing problems for those investors that stipulate rated securities only as part of their mandate. Additionally, there are also many impediments around the issue of public offer documentation, again making it difficult for corporates to come to market. As such, the domestic market remains relatively concentrated compared to other markets, and with very few sectors (beyond banks and financials), the opportunity to build diversified portfolios is more limited (especially relative to the US). Fixed interest specialists and distributors of direct bonds FIIG have assisted many of these small corporates come to market and have additionally been working on a structure to bring these bonds to the retail market in a more diversified offering.  

This advancement in product offering by managers such as FIIG aligns itself to a general industry shift that we have seen in the last few years whereby we have seen significant enhancements to the types of offerings within the fixed interest market in Australia. Not only have we seen a significant development in the type of unlisted managed funds entering the Australian market – e.g. absolute return focused bond funds, unrestrained global bond funds, etc. – but the expansion of Australian listed exchange traded funds (ETFs) into global fixed interest, as well as the introduction of CGBs on the ASX, has further expanded the product offering, not just in terms of strategy but, importantly, product structure as well. We are supportive of all efforts to make bond investing more visible and accessible to a broader market.  

In quantifying this change, as at October 2017 Lonsec rated 142 funds in the fixed interest sector (up from 127 funds in 2015), covering unlisted managed funds, ETFs and managed accounts (e.g. separately managed accounts [SMAs]), and this trend is expected to continue as demand for income-focused solutions expands. [[{"fid":"32199","view_mode":"default","fields":{"format":"default","field_file_image_alt_text[und][0][value]":"","field_file_image_title_text[und][0][value]":""},"type":"media","attributes":{"style":"height: 563px; width: 500px; float: right;","class":"media-element file-default"}}]]

The managed accounts structure specifically is one that has grown significantly in Australia in recent years with the Institute of Managed Account Professionals (IMAP) estimating the market in Australia now stands at nearly $50 billion, an increase of approximately $8.79 billion, or 22.4 per cent, since December 2016 (this includes a number of new entrants to the survey). Additionally, according to a recent survey conducted by Morgan Stanley, this number is expected to grow to $60 billion by 2020. However, data around the growth of these structures is still relatively ambiguous with many conflicting numbers being released, making it difficult to understand the real size of the market and potential growth. Even more difficult to assess is the way funds are allocated within these structures. According to Lonsec data, they currently rate 28 managed account portfolios. This represents predominately SMAs, as managed discretionary accounts (MDAs) and individually managed accounts (IMAs) are more difficult to evaluate. However, if we look to this as a sample size, it is not surprising that Australian equity portfolios make up over 73 per cent of those on offer and global equities over 17 per cent. With 90 per cent of strategies on offer being equity strategies, the remaining 10 per cent is equally weighted between Property, Multi Asset and Fixed interest. 

Whilst the availability of fixed income portfolios in particular remains very thin, we would expect it may grow in time and for demand to pick up as investors who may be seeking exposure to listed fixed income securities look to professional managers offering managed accounts. This may also be an effective way of managing some of the operational and governance issues discussed above. With fixed interest specialists such as FIIG moving to now offer product within this, it reinforces the Lonsec view that this is a growing asset class with growth both in demand and in product offerings. 

To date, income portfolios offered through managed account structures are predominately made up of listed securities such as hybrids (preference securities). Whilst these securities generally offer higher yields than bonds and bank deposits, they also rank lower on the capital structure and therefore expose investors to higher risks and a higher correlation to equities. These types of portfolios are very different to those that combine debt securities from further up the capital structure – such as investment grade debt.  

At Lonsec we believe that it is very important that every investor understands their underlying exposure to fixed income securities. Investors should understand the real risks involved, the restrictions and boundaries around the investment guidelines, and the maximum weightings at each level of the capital structure. The fixed income universe if vast with many more securities issued in debt markets globally than equity markets and additionally, the risk/return is hugely dispersed. Therefore, investors should not assume that fixed income securities are all the same and, accordingly, all safe.  

Given all of these concerns to be aware of, why would an investor go down this avenue in favour of a traditional managed fund portfolio? The answer is likely to be that because they are not pooled investment vehicles, investors may be attracted to the idea that beneficial ownership and perceived control of the underlying securities remains with the investor. This appears to be a particularly sought after attribute for the SMSF market, especially where control is one of the primary objectives, as is tax efficiency through direct ownership and more transparent and comprehensive reporting. However, it would be remiss not to mention that the most significant disadvantage of this type of structure in sectors such as fixed interest is diversification.  The universe of fixed interest securities and issuers in Australia is relatively narrow and concentrated in financials and, as such, any accompanying portfolios would be considered highly concentrated in comparison to more traditional managed fund offerings. Additionally, the minimum investment required could be considerably higher than traditional managed funds or ETFs, as well as the fees. 

Overall, the broadening of the opportunity set available for fixed interest investors may only be a good thing. In addition, direct access to fixed interest securities through structures such as SMA/MDA

The story so far:

Gaining traction with $200m in FUM

With around $200 million in funds under management (FUM) after barely 12 months, FIIG’s Kieran Quaine seems justified in his belief that Managed Income Portfolio Service (MIPS) product is gaining the sort of traction he has been looking for.

The key to FIIG’s MIPS offering is undoubtedly its entry point – $250,000 – something which places it in the sweet spot for high net worth investors and has doubtless helped drive inflows over the past 12 months.

From Quaine’s perspective, advisers and investors need to recognise the manner in which FIIG’s underlying capabilities serve to differentiate the MIPS product in the market in circumstances where the company is a leading originator of high yield debt at the same time as delivering direct bonds.

“FIIG represents a one-stop-shop for that,” he said.

According to Quaine, one of the attractions of the MIPS product is the stability of income it offers at the same time as having the capacity of delivering equity-like returns.

He points to the product’s performance over its first 12 months which stood at 5.1 per cent for the 12 months to 30 June.

FIIG and Quaine see the MIPS product as being particularly relevant to more mature, later stage investors who are looking for an investment offering stability similar to that of a term deposit  but with more opportunity to grow their capital in a controlled and predictable way.

Such investors were also likely to be attracted to the fact that they had the capacity to bank their returns or to re-invest.

While $250,000 represents the entry point for the MIPS product, a number of investors have already opted to go higher and Quaine said that where higher amounts were in play fee compensation discounts were on offer.

He said the highest individual investor to date had tipped around $60 million into the product.