Short duration domestic fixed income offers an alternative to term deposits
As term deposit rates in Australia continue to decline, many investors in search of capital preservation and income are looking for alternatives. PIMCO’s Australian Focus Fund, a short-term fixed interest strategy that fills the gap between cash investments and bond funds, can offer a solution. Below, Portfolio Manager Robert Mead discusses the fund’s investment strategy.
Q: What is PIMCO’s Australian Focus Fund?
Mead: The Australian Focus Fund (AFF) is a very high-quality, short-term fixed interest strategy that invests in a range of bonds, primarily from Australian issuers. It aims to preserve capital while providing a higher return than cash investments – notably term deposits. It also offers daily liquidity, which is an advantage for investors who want to be able to draw down their investments when the need arises.
The fund has a lower duration than typical core bond funds, which means it is less sensitive to changes in interest rates, and as a result, has lower volatility. It can therefore help preserve capital when interest rates are volatile or rising.
Q: Why did PIMCO design the fund?
Mead: When we originally launched the Australian Focus Fund in 2009, it was designed to fill a gap between cash investments, such as term deposits, and core Australian fixed interest strategies.
With term deposit rates continuing to fall, AFF now offers investors a viable alternative to term deposits. Because the fund can invest in securities that yield more than cash instruments, it can offer higher returns than term deposits; and because AFF focuses on high-quality bonds and is less interest-rate sensitive than typical bond funds, it can be used to preserve capital, as term deposits are.
While term deposits often charge penalties for withdrawing money before maturity, investors in the Australian Focus Fund can tap into their investments at any point with only modest selling fees. We believe this is an important feature for investors who have accumulated savings and may want to be able to access them. Retirees are a good example.
Q: What types of securities does the Australian Focus Fund invest in?
Mead: The fund invests predominantly in high-quality, liquid, Australian securities: Australian federal and State Government bonds, corporate bonds and high-quality residential mortgage-backed securities. A large portion of the securities in the portfolio are rated triple-A.
Q: Where do you currently see value for the fund?
Mead: PIMCO believes that the Reserve Bank of Australia will need to provide further policy support to stimulate economic growth as mining investment declines, and will lower interest rates. In general, this should be supportive of Australian government bond prices going forward.
In addition, we see strong value in bonds issued by Australian companies abroad in other currencies, such as the US dollar and the euro. After hedging the currency risk, we see many of these securities offering very attractive returns.
We are cautious on the State Government bond market currently; some State Government balance sheets have deteriorated over the past few years with some States losing their AAA rating. That said, many State Government bonds offer significantly higher yields than comparable federal government bonds and still have very high credit quality and therefore attractive risk versus return profiles over Australian government bonds. So we have invested in these securities selectively.
Q: What is the benchmark for the Australian Focus Fund?
Mead: We use a combined benchmark: 50% UBS Australia Composite Bond Index and 50% UBS Australia Bank Bill Index. The benchmark reflects the unique positioning of the fund between the cash markets and the bond markets.
FUND OVERVIEW | AUSTRALIAN FOCUS FUND 3 We invest in securities outside of the indexes when we see the potential for additional return and we can also alter the duration of the fund to 2 years above or below the benchmark duration. This flexibility allows us to shorten duration to be more defensive in volatile and rising rate environments and extend duration to take advantage of bond price gains when interest rates fall.
Q: What role can the Australian Focus Fund play in an investor’s portfolio?
Mead: The fund can play several roles. First, it can be part of a core defensive element in an investment portfolio. Specifically, it can offer diversification away from risk assets, such as equities, which have been prone to volatility and sell-offs during “risk-off” periods. AFF has generally had a negative correlation to equities.
The Australian Focus Fund can also be a strong income generator in a portfolio. Historically, the fund has provided returns far above inflation: about 5% above the Consumer Price Index every year since inception. PIMCO’s quarterly distribution policy, which allows the fund to pay out its total returns as distributions, has also made the fund attractive for investors looking for income.
Overall, the Australian Focus Fund has achieved strong returns in a challenging investment environment. Since it launched, the fund has outperformed both cash investments and its benchmark, which makes it an attractive alternative to term deposits. We believe the Australian Focus Fund is well positioned to meet investors’ increasing needs for capital preservation, yield and liquidity in the years ahead.
About PIMCO
PIMCO is a leading global investment management firm, with offices in 12 countries throughout the Americas, Europe and Asia. Founded in 1971, PIMCO offers a wide range of innovative strategies to help millions of investors worldwide meet their needs. Our goal is to provide attractive returns while maintaining a strong culture of risk management and long-term discipline.
