Active management – where our team is continually looking to buy or sell different investments over time as their relative attractiveness changes – is fundamental to Milford’s investment approach.
My colleague Mark Riggall recently explained in a brief video how we deploy this strategy in the share market, and the benefits therein.
But what does active management mean for Milford’s bond (or ‘fixed interest’) portfolios?
The key principles are the same.
Valuation (yields) and future prospects for different bonds are always changing, depending on the outlook for interest rates, currencies, and the strength and outlook of the companies (or governments) that issue those bonds.
These movements create opportunities for an active manager, but it is critical to conduct the right research into these companies and themes.
Ian Robertson, a Senior Fixed Interest Analyst at Milford, recently wrote a blog here about the similarities and differences between fundamental company research relating to shares, compared to that on bonds.
In addition to these fundamental factors, we also pay close attention to which of an individual company’s bonds offer the best value. There can be significant variations in yield across different currencies – for example, Fonterra’s bonds in NZ dollars compared to Fonterra’s bonds in British Pounds. Therefore, we believe it is important to have a flexible approach that allows our Funds to take advantage of these discrepancies.
Our ongoing assessment of both fundamental and valuation factors drives our active investing in bonds. We buy bonds which we see as attractively valued for the risks involved, and (hopefully) later sell them at a higher price.
If we execute successfully, our bond funds are able to generate a return that substantially exceeds what a passive strategy (that simply purchased each new bond as it was issued, and then held it until maturity) would earn.
In addition, our bond funds take active positions regarding the overall direction of interest rates, credit spreads (the extra yield from owning a company bond, relative to a government bond), and to a lesser extent, currencies.
A good example of this came in the first quarter of this year, when we were concerned about the prospects for rising interest rates, especially in the USA and Europe. Our bond funds (including our diversified funds that invest in bonds – such as the Diversified Income Fund and Balanced Fund) were able to position, using derivatives such as bond futures and options, to benefit from this movement. As a result, this active management generated a return that was substantially better than what a passive bond strategy would have delivered.
At Milford, our active management in bonds is much more focused on opportunities at the individual company and bond level, as opposed to frequent aggressive positions in overall interest rate markets. This is because we believe our ‘success rate’ in the former is much higher; firstly, due to our focus in this area, and secondly due to a lower number of investors concentrating on this strategy.
That said, as for our share funds, we also think that a broad approach, with many different levers available to generate returns in different phases of a market cycle, is critical to delivering higher returns and managing risk over time.