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The ‘case for active’ in fixed income is strong

This week we had the pleasure of speaking with fixed income gurus Mark Mitchell and Justin Tyler from Daintree Capital to get their view on the interest rate and inflation outlook together with some insights into their Core Income Fund.

Daintree is a specialist Australian active fixed income manager and part of the Perennial Group established by Mitchell and Tyler in 2017. Mitchell has over twenty years under his belt of industry experience both in Australia and the USA, specialising in fixed income securities analysis and portfolio management. Tyler is the co-founding partner of Daintree, in charge of interest rate and currency decisions.

Mitchell explains that their approach to fixed income is “more towards the conservative end, it’s designed as a defensive product structured towards investors that have already generated wealth and are looking for low risk income, short duration type products that have a capital preservation factor as well.”

The fund is an absolute return strategy that targets the RBA benchmark interest rate + 1.5-2.0% net of fees. The target chosen because of its conservative properties. To go higher up the return curve, Mitchell explains, it would add further risk which would in turn lessen the fund’s defensive appeal. “This rate strikes the perfect balance and trade-off between return and protecting capital”. There are numerous ways in which this fund can be structured to achieve the targeted return, and Daintree has opted to use corporate credit in addition to a range of derivative overlay strategies.

Mitchell highlights the great relationship and partnership Daintree has with Perennial who have an equity stake in the business and also help support with marketing and distribution. He says “it’s worked really well for us, FUM is now up to $520m and that’s growing. It can take a few years to get traction due to ratings and platforms.”

Tyler, who is the technical brains of the investment fund, explains how “interest rates have fallen so far and because most investors hold fixed income in a passive way, it has tended to not be an asset class for active management. Equities wear the active cap, but the income portion sometimes tends to be forgotten in the active/passive decision.”

“We think the case for active is pretty strong. When you’re investing in a corporate bond one of two things can happen: One.. you’re going to get your regular interest payment and principal returned or two.. the company will decide not to pay you back and you lose. So, the downside is much bigger. For us that opens up a whole scope for active management. You need to be active, because its not about picking the winners, its about avoiding the losers.”

And what Tyler says makes complete sense. Why would you invest in a passive fund with the benefit of a slightly lower fee, that loads up on a stack of long duration corporate bonds? The risk of default from any of them raises the risk of that fund. “

Tyler has a key message for investors looking for fixed income exposure, “It used to be easy to invest in fixed income because interest rates were at a reasonable level and you were almost guaranteed a decent return. You also had an asset that was safe, a defensive play. Fast forward to today and most of that upside from lower interest rates is gone. It’s difficult with interest rates so low to achieve the same return, so investors take on higher credit risk. This is where our expertise comes into play. We take on very low duration corporate bonds, about half a year.”

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