What are you missing in fixed income portfolios?
The events of 2022 have brought the fixed income and defensive allocations of multi-asset portfolios back into the spotlight. The reversal of recent gains in long-duration bonds, combined with a jump in credit spreads, has challenged even the most patient investor. It has also highlighted a unique challenge of applying a passive, broad-based approach to constructing the defensive part of the portfolios.
Kevin Toohey, principal at Atchison Consultants, this week asked the question of advisers “what are you missing?” in reference to fixed-income allocations. He is referring to the composition of the Bloomberg AusBond Composite and Bank Bill indices, against which most fixed-income investments are benchmarked in some way or another.
While the off-index exposures of equity managers are usually “relatively minor,” Toohey highlights that “whole categories of securities are excluded from the fixed-income benchmarks.” This is particularly relevant for the financial advice sector now that the Your Future Your Super rules have effectively pegged industry and My Super products against the Composite index.
Sticking with the Composite Index, Toohey flags that this only includes eight sectors of the fixed-income market including federal and state government and then into corporate and some fixed-rate residential mortgage-backed securities (RMBS). It explicitly excludes floating-rate RMBS, anything below investment-grade, along with the extensive range of other asset-backed options that make up a substantial portion of the debt market.
The result is that the AusBond Composite index only measures a “slice” of the debt market universe. It doesn’t help much for those who invest in other parts of the sector, which traditionally benchmark against the Bank Bill Index, which only considers the performance of bank-issued short-term bills.
This opens a wide range of opportunities for financial advisers able to work outside the restrictions of the YFYS benchmarks, and a potential source of long-term alpha. He flags a few key questions for advisers to consider; the first being whether a more nuanced benchmarking of fixed-income allocations is warranted, such as splitting this into fixed, floating and inflation-linked sleeves.
It becomes more important to understand and monitor the key characteristics differences between a portfolio and the benchmark, and either use specific sleeves to manage weightings or at the very least know where potential diverse performance is coming from.
But most important, it is about understanding the limiting nature of the benchmark and seeking opportunities to leverage this for clients where appropriate. Putting it into context, Toohey says “using the AusBond Composite benchmark is like only using the election result of Queensland to call the Federal election.”