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Podcast - Fixed Income

Stefan Angelini is Joined by Adam Curtis from Perpetual to discuss investing into Fixed Income, or put simply, lending your money like a bank. We dive deep into different types of debt, the risks you should take in the space and what returns you should expect. Angel Advisory manages the wealth of high income earners and high net wealth individuals and families. Investing into different asset classes including this.


Stefan Angelini

Alright. Alright. Let's go.


Adam Curtis

Thanks for having me.


Stefan Angelini

Hey there, welcome to another episode of the investor type podcast. I'm your host, Stefan Angelini. And I'm here today to talk about fixed income or what people might commonly known as cash term deposits. But what people don't know is that this does get a little bit more intrinsic and six year the products in here to talk about six evil got Adam Curtis from Perpetual


Adam Curtis

Thank you Stefan, glad to be here.


Stefan Angelini

Thank you very much for coming on.


Adam Curtis

Absolute pleasure


Stefan Angelini

When it comes to investing in especially talking about fixed income we can get quite boring, quite laborious. And I've heard you talk many times about this, this information and all types of investing, but you've got a way to make your make your investing sound. I know, different interesting. How do you do it?


Adam Curtis

Look, I think, you know, it's an exciting asset class or beta doesn't get the cachet of, of other markets. I think that's a shame. It's the biggest of all capital markets. It's the oldest, but it's the most important, you know, and if you understand fixed income, all the other asset classes fall into place. I think that the real challenge with fixed income is in its breadth a lot of investments can sound very similar, but can be very different. The key to understanding fixed income is forget about it is thinking about fixed income. Think about it as lines. Think about it as lending, because that's all fixed income means, think about the length of the loan you want to make. Think about the quality of the borrower. We call that credit quality. Some people call it tenor. But if you understand those principles of don't lend too long, don't lend to someone that you don't think will pay back. The beauty of fixed income lies in its predictability.


Stefan Angelini

And when you come to the quality of the borrower, you can talk about borrowing money to governments.


Adam Curtis

Yeah, yeah, that's right. There's all sorts of different borrowers out there and to a degree, the returns in fixed income commensurate with the top of credit risk all that all the top of the bar, you lend to lend to a government, you've got a very low risk of not getting paid back. But conversely, you've got a pretty low yield lend to an investment grade company, you get paid a little bit more than lending to a government lend to a sub investment grade company, you can get a return that sounds like equity, that you might not get your money back. So the more credit risk that you take in a portfolio from lending to a government or lending to it investment grade company to lending to someone that doesn't have sort of the balance sheet, the greater the opportunity for returns, but also the greater the opportunity for potentially risks that you're actually seeking to avoid


Stefan Angelini

100 percent and there are risks in lending different kinds of governments.


Adam Curtis

Absolutely. Well, you know, we've seen that a little bit over the last few years. I think one of the most oversubscribed bonds in the last couple of years was the Argentinian government bond that people were just clamoring because of the yields associated with it


Stefan Angelini

where the


Adam Curtis

I think at that point, there are sort of eight nine ten percent relative to sort of, you know, government bonds in Europe in the US that we're paying you effectively no thing in some cases, negative yields. But it's interesting to that point, because it's a good point, you make stuff and that asset now is I think, trading at about 50 cents in the dollar. So many investors buy an asset based on the sense of I get the promise of a great return, but they may actually find that they're actually getting risks that they that they don't see until they see and that's the the real challenge with fixed income


Stefan Angelini

100% and when people go into the asset class or the old spice they go, well, this is a risk free environment.


Adam Curtis

Yes.


Stefan Angelini

I typically associated with cash term deposits


Adam Curtis

Yeap.


Stefan Angelini

To won right back. When you look at cash term deposits, they're mainly operate off the make build swap right or the by and large interest rate in the economy. We've got Australia right now.


Adam Curtis

Yep.


Stefan Angelini

Why? A lot of Australians love term deposits.


Adam Curtis

Yeah.


Stefan Angelini

Because you've got if you invest less than $250,000, into a big bank,


Adam Curtis

Yeap.


Stefan Angelini

it's get, it's backed by the government.


Adam Curtis

Yeah.


Stefan Angelini

So your money is partly secured there.


Adam Curtis

Absolutely.


Stefan Angelini

But there are falling interest rates at the moment. So people are sort of clamoring as to what to do


Adam Curtis

Yeah.


Stefan Angelini

Why do you see interest rates falling?


Adam Curtis

Look, it's a conundrum to a degree, I suppose interest rates are falling because in essence, the Australian economy is not performing necessarily as strongly as, as a central bank and our governments would like and they're using, you know, fiscal stimulus to try and keep that in. But you make a good point. I think good portfolios, whether it's fixed income, or more broadly have a blend of, of assets and blends of different risks and term deposits can provide part of the solution. But I think in today's climate, if the only asset that you owned in fixed income was term deposit we're doing yourself out of opportunities, and you're introducing the risks that you're introducing a return. That's insufficient to fund the retirement all the investment goals that many people have.


Stefan Angelini

Yeah,


Adam Curtis

so I think good portfolios will hold term deposits. What's the right mix is a function of someone's attitude towards investment horizon and return. The challenge, I think today is that a lot of fixed income investments are performed particularly well, retrospectively, because interest rates have fallen, that sort of historical return may not necessarily be replicated. if interest rates bank continue to fall, and mathematically, they can't continue to fall like I have. So the real challenge in life like it is in investing is that what's worked well in the past is unlikely to work well in the future. And that's really important that you understand what you buy before you necessarily buy it.


Stefan Angelini

And that's so interesting that even though interest rates turn deposit rates are falling fixed income, that space is still growing dramatically because of that.


Adam Curtis

It is I and I think this goes back to the original question, Stefan of understanding fixed income, you know, a perpetual we've done a fair bit of work with our clients on trying to help them understand it and and it really resonated with me that that some of our clients and some of the people that we work with in the in our families are being fixed on income investors. But when investing in funds, they're really comfortable with the concept of what we call term deposits. term deposits. you lend to a bank, a bank lends to you as a business owner may as a homeowner, but I leverage it up the benefit for all those extra returns go to shareholders in the term deposit, in essence, base the in essence, the lowest return for that, I'd look at fixed income is not necessarily lending to a bank, but lending like a bank.


Stefan Angelini

Yeah.


Adam Curtis

And the difference is that you as the lender of the capital benefit from the margins similar to the banks, in essence lending to you and I or or other sort of people. And I think that's that what people need to think about today in a climate where risk is is sort of poorly priced. Cash rates are low government bond yields are low. as investors we're chasing returns, but we can well chase returns at the expense of actually what we're trying to do which is manage risk. Good fixed income portfolio. As really provide the total portfolio, all the other investments in that portfolio, the ability to take risk with greater confidence. Because if you structure your fixed income assets, well, you've got the capacity to take risks in asset classes where you're rewarded. equities are about making you money. Fixed Income is about giving you the confidence to make money. And I think sometimes in today's climate, we run the risk of people buying fixed income investments that sound too good to be true. True.


Stefan Angelini

Yeah.


Adam Curtis

And they may well find that they actually are.


Stefan Angelini

That's that's part of the trickiness in the space,


Adam Curtis

it isn't it is and enter that in there is some simple questions. Investors should be asking themselves, at the group that's putting the product in front of them. Look at the offer document, what's the type of borrower is there? How many borrowers? How diversified? Where are you in the capital structure? What's the length of the line? What's the type of line? Is it fixed? Is it variable? Is it what they call short duration is? These are hard questions. But frankly, they're the most important questions to ask because once you know those, you'll know exactly how to perform. We call it the fixed income toolbox happy to send it to you for your for your clients and listeners at a later point in time, but quality of line tenor of line subordination of line once you answer those questions, you've got a very clear picture of what you buy.


Stefan Angelini

Yeah. And so you are a perpetual perpetual manager approximately 25 million worth of money


Adam Curtis

25 million dollars. Yeah


Stefan Angelini

which is a lot and that means you got a lot of assets at your disposal in order to get more access to these companies and who you're lending money to correct your average Joe and straight can really get access to your your cash rights and your term deposits.


Adam Curtis

It's it's really hard. It's a really good point. I mean, in some regards, the most commonly traded security, but people familiar with a shares, you can trade them on exchanges, fixed income to a degrees and traded often on exchanges, they traded effectively what they call OTC or over the counter. So the minimum parcel size for most fixed income assets outside of cash and term deposits and things like that. A 500,000. And not many investors have just one 500,000 dollar investment to make one line.


Stefan Angelini

That's because you're lending money


Adam Curtis

correct?


Stefan Angelini

Yeah.


Adam Curtis

Key risk and fixed income is a symmetric make a bad line in you might not get your money back. So ironically, you actually want to manage risk in fixed income differently to equities. I think you're rewarded for concentration risk in equities, I'd be happy to line a portfolio of 10 or 20 shares. But in fixed income, we would average probably a hundred lines. Because if one line doesn't perform like you expect, you've got 99 other lines kicking in, where the reality is, if you've got five lines or one goes bad, you could be waiting 20 or 30 years to get your money back on the total portfolio. And that's the risk that investors need to be aware of today, there are plenty of products that are offering people yields as seven 8%. How can you find fixed income and it'd be defensive and predictable when cash rates are 75 points and someone's targeting a yield of 8%? There's something wrong there.


Stefan Angelini

Yeap. Those those kinds of risks that people take, they're just you need you need to have enough drop. Yeah, and that's why that's why we pay businesses in order to manage that fixed income risk. In terms of how much report file people normally have.


Adam Curtis

Yeah.


Stefan Angelini

Into fixed income. You said you love your equity space


Adam Curtis

Yeah


Stefan Angelini

Because you've got the growth there. And that's we try to focus on fixed income does play a certain role.


Adam Curtis

Absolutely


Stefan Angelini

Follow more of an income.


Adam Curtis

Yeah,


Stefan Angelini

Your overall


Adam Curtis

It does. And I think like someone's allocation to fixed income is a function of of sort of different questions for different people. Sometimes it's their attitude to risk. Sometimes it's their capacity to absorb risk. A young investor in accumulation, in my opinion, probably doesn't need a great deal of fixed income, they might own some for some liquidity or some optionality that they've got. But their job and our job in the industry is how do we grow their wealth. You get to a point in your investment journey where you're focused moves from growing wealth to preserving wealth. And I think through that sort of investment journey, potentially your exposure to fixed income can grow by the nature of your capacity to absorb risks. And there are other investors, statutory bodies like hospitals and health funds, etc. Insurance companies that have investment policies that that really prescribe them only investing in fixed income to a degree. So really, I think someone's exposure is a function of what they can do and what they want to achieve.


Stefan Angelini

Yeah.


Adam Curtis

The question I think people need to think is when they buy fixed income, is it really fixed income? Or is it something that's sort of dressed up as fixed income, but actually is probably more equity risk.


Stefan Angelini

Yeah. And then that's when you start to lose all your money. And we typically associate fixed income with something that you can sell down in cases a rainy day in the equity market start to fall off, you expect your fixed income exposure to sort of relatively remain unchanged, hopefully,


Adam Curtis

Yes,


Stefan Angelini

To provide you an income.


Adam Curtis

Yeap.


Stefan Angelini

And we when we look at look at a bucket approach with clients as our, when do you need your money? And when do you need to draw down on your money?


Adam Curtis

I think that's the perfect way to think about it


Stefan Angelini

Yeah, when you go to fixed income when you go to a portfolio of assets, whether it's in your own name, or when do you need assets, access to those money? And do you need them to pay you an income so some people that might be focusing on an early retirement, retiring at 50, and not looking at this super fund yet, whereas with people that are using this fund as I do start to approach the 60-65 looking towards retiring, then I really need to start allocating maybe more more money towards these fixed income spaces. Because you don't have that risk that up and down, you do get paid that you do get paid your income


Adam Curtis

Potentially


Stefan Angelini

Yeah,


Adam Curtis

I think I think that's and that's the beauty of fixed income. Like, as investors, we don't know what the price of always will be in three years. But we know always will be here in three years. So from a lending perspective, if you're happy to invest with them for three years on a line, and you're happy that you've got the investment horizon to invest for three years, the predictability of the return is very high. The predictability of the capital return is is almost guaranteed. The key risk in fixed income is don't invest in something longer than you think. You've got the capacity to own it, and effectively don't invest in fixed income if you've got the expectation of equity like returns. To me, fixed income is all about giving you predictability to take the risks in parts of your portfolio we are better one for risk, and that's challenging in today's climate, with low yields


Stefan Angelini

And when these companies, these bigger companies talk about words where they go out to the market, and they, they asked for money,


Adam Curtis

yes


Stefan Angelini

to borrow


Adam Curtis

Yeap.


Stefan Angelini

From your newmark called a hybrid.


Adam Curtis

Yeah.


Stefan Angelini

And then that might be an asset class, it's an enhanced yield, whereas, you know, you're not, it's not your typical fixed income product, but they've got different levels of their debt structure, which gives you that different confidence of getting your money back.


Adam Curtis

Absolutely. You know, typically in in markets, we refer to that as the capital structure and depending on the company's their biological four layers to most companies capital structure and, and the top of that capital structure is effectively senior, often it's secured, then you not move into subordinated debt. And then finally, modern, moving to what's called the hybrid charge, and then finally, equity. All things being equal. Every time you move down the capital structure, you get a greater return, but you also ranked lower.


Stefan Angelini

Yeah.


Adam Curtis

And so I think that's really important that in some regards that investors in fixed income they get paid the coupons before shareholders get paid their dividend. In the event of companies getting into problem, then shareholders lose their equity. Before bondholders contribute equity and in essence works through the capital structure, so stay short stay at the top of the capital structure. Yes, returns might be a little bit lower, but the predictability of the asset class easy in that space.


Stefan Angelini

Yeah. And you talked about, especially with these asset classes, riding it out, and being able to dedicate to that that period of time, whether it be three years by the 70s,


Adam Curtis

Yeah


Stefan Angelini

Typically with days they are liquid, so you can trade in and have it if you do need the money,


Adam Curtis

Absolutely.


Stefan Angelini

However, if the if the capital price you do pay for these does go down, then you're going to be losing money.


Adam Curtis

Potentially, I think the only risk in fixed income is you sell something in a in a in an environment where risk is differently process and you bought it outside of that if you're in in in the investment, in broad terms equivalent to the length of the lines or the the average loss of the lines, then the risk of that capital volatility is pretty minimal. But you can see scenarios where if you bought a fixed income investment the day before the credit crisis in the GFC and tried to sell it in the midst of the credit crisis, you might sell 80 cents in the dollar. But conversely, for the investors that bought it at 80 cents in a dollar, two years later, they were getting a hundred cents in the dollar. So the real risk in fixed income is don't sell it at a point where you're not happy with the price, or don't buy assets that trade at that price.


Stefan Angelini

Yeah,


Adam Curtis

You know, quality assets, always a liquid and quality assets always has the visibility. And that's what it's all about. If you keep it short and keep it high quality. Other investors want that asset because they want visibility and predictability. The real risk in some regards, is sometimes that's hidden, you know, the average length of the line sometimes can be hidden, the type of subordination you referred to before can be hidden. You know, bank hybrids can play a role in a portfolio but why not own the bank shares because that's where you get the upside. And I'm the senior debt for the predictability and perpetual with the third are equity risk in in banks and senior debt in banks than getting typically lost in the capital structure where we feel that we we own the equity risk, but we don't necessarily get the equity return in that space. Both things that dynamic and they can change


Stefan Angelini

Yeah. So this fixed income space as you really start to drill down into it, there's a little talk than than the average I can see.


Adam Curtis

Yeah, yeah,


Stefan Angelini

that's when you when you're involved in the industry, you really get to see that


Adam Curtis

it's really important. You know, you look through every advisors, IPL or list of investments that are available to direct shareholders even in the listed markets now. And there are products that sound awfully similar, Stefan, they sound awfully similar to me. But I'll tell you what they can perform awfully differently in different environments. And I think the most important thing that I'd counsel investors if they're not sure, don't do it. And if they're not sure, seek advice, talk to the professional advisors talked to fund managers, and if they don't like the answers they're getting, then they should steer clear, but like anything, if you understand what's underneath the bond, you'll have a pretty good understanding of how it will perform. In today's environment. I would caution investors from buying stories about returns, that I'd be working with companies that focus on risk because it's really important to manage risk and accept the returns that come from it rather than design returns and they accept the risk that's commensurate with it


Stefan Angelini

Yeah. And through growth through periods of greater returns, obviously, the risk is lower, it seems lower. But as the market starts to turn, the risk becomes a lot higher. And you spoke before about during the GFC companies or these hybrids, losing 20% of the market


Adam Curtis

Even more, in some cases


Stefan Angelini

Have you seen any of the horror stories where some of these companies have gone bankrupt, where people have lent these monies or borrowed monies that they thought was secure?


Adam Curtis

I think there's examples of that all the time. It's not examples that we have a lot of a perpetual because we're not in that space. And we're in the space of finding quality businesses and lending to quality businesses. So you know, those type of assets happen in the market, but they're not sort of consistent in in stories in our portfolios. But there's plenty of examples of investors that have made direct investments in high yield companies that have got cents in the dollar in recent years. You know, Mica Mica sugar is a is a one that comes to mind.


Stefan Angelini

Yeah,


Adam Curtis

But there are companies that were investment grade companies years ago, they don't exist. I mean, Lehman Brothers is a perfect example. I think I righted investment right in investment Bank of Global Reach and you know, some people lost you know effectively all their money in that insane you did in Lehman's I think you were getting for 75 cents in the dollar. So even though the company bankrupted an equity holders lost everything hybrid investors lost everything. People who were at the top of the capital structure still record recovered, I think that eighty cents in a dollar.


Stefan Angelini

And there's a risk mitigation that if you are relying on your to keep your money throughout your retirement or things like that these fixed income exposures, you still get some money back hopefully at the end of the day, if you're higher up the risk that was changed.


Adam Curtis

Absolutely. It's a trade off with with everything. At the end of the day, there's no free lunch in investing. And I think that's the key died. What are your expectations of fixed income? And if you come to any investment decision with clarity of what are the attributes I want from this, and I'd encourage investors to think that the role of fixed income is get your money back, have predictability, get an income stream that sort of cash or better than cash through the cycle. And when you find those attributes, you'll get a return that we think is probably about 2% above cash now 2% cashes, 3% today


Stefan Angelini

Doesn't sound great doesn't


Adam Curtis

It doesn't represent about cash.


Stefan Angelini

Yeah.


Adam Curtis

But I think if people are thinking about getting eight or 10% from fixed income, they're not buying fixed income. And that story will change. And we've seen that in previous cycles going into the GFC. We sort of saw that in. In other markets. We saw that in, in what we're credit markets where investors were happy with the returns, and they levered the returns. They's structured the returns, and we came up with all those products that were called CDOs and CPDOs and COLs and they're all credit rated. Many investors got burnt chasing a few extra bits.


Stefan Angelini

Yeap.


Adam Curtis

In pursuit of higher returns, they lost sight of the risk. And that's why I would encourage people to seek professional advice or work with professional managers. At the end of the day, professional managers aren't generating better returns better risk adjusted returns that investors can do themselves. There's no reason for people to use them. So the ultimate alarm and he's fine managers that can show you the proof of of of of of the skill and the value that comes from your active management


Stefan Angelini

100% 100%. And this is where we get on to you know what kind of invest that goes into these kinds of investments. Obviously, you've got different spectrums. So let's start down from the beginning, cash and term deposits, what kind of investor would be investing in cash in term deposits?


Adam Curtis

Look, I think, you know, everyone has a role for liquidity in to make cash and to a degree short data term deposits are really a liquidity bucket. You know, you might have that in terms of meeting an immediate cash flows, you might have that if you've got particular saving goals in mind. So there might be a young investor that's saving up to build, you know, a portfolio of cash for house investment, you know, cash in term deposits makes sense for them. A retired investor that's got cash flows to make for their ongoing lost all expenses, keep it short, keep it liquid, but I think outside of that much more money in cash and short dated term deposits is under selling the potential returns you can get from other parts of your portfolio.


Stefan Angelini

Right and potentially getting beaten by inflation.


Adam Curtis

Correct


Stefan Angelini

At the moment?


Adam Curtis

Well, I think at the moment, inflation came out yesterday, I think at a point eight in the quarter, well, that's, that's the cash rate down


Stefan Angelini

Yeah,


Adam Curtis

You know, in 3 months beta


Stefan Angelini

And then you got you go, you got further up the further up the risk, the risk profile.


Adam Curtis

Yeah


Stefan Angelini

And when you're tagging these these hybrids or lending to, to good to good governments or two good businesses,


Adam Curtis

Yeah.


Stefan Angelini

What kind of investable would lend money to these kinds of,


Adam Curtis

Again, I think I think they form a part of any sort of fixed income portfolio, but the type of investors that might buy credit and credit on stays lending to non governments and they can still be very high credit quality, our investors that are trying to get something better than cash, but are also biz you know aware to accept that there is some small volatility in the pursuit of that high return. So that would be what I'd call credit enhanced or cash plus type investing. Typically, I'll expect that to achieve investors somewhere like 100 points to 200 points above cash or one to 2% above cash. So long as they've got a two to three year horizon, I think that's pretty indicative of the high quality investment grade portfolio. You know, if you're wanting to return above sort of 2% above cash, then you're going to start moving down the capital structure, you're going to be into subordinated debt, or you're going to be into low debt at it. Nothing wrong with that, but understand that the greater the credit risk in your fixed income, or the greater the tenor of the loan that you make in your fixed income, you're going to get paid more for taking that risk. But you also introduce higher correlation with equity, you also introduce high volatility, which may in fact, be exactly the things that you're trying to reduce.


Stefan Angelini

That's right. So these people need to be comfortable with their money going up and down,


Adam Curtis

Correct


Stefan Angelini

With them potentially not getting their capital back. While market rewarded with higher income rates,


Adam Curtis

Yes. That capital piece that they so dearly rely upon, is at risk. Exactly. And the challenge is the same. The same problem would exist if people traded and valued term deposits on a daily basis.


Stefan Angelini

Yeah.


Adam Curtis

At the end of the day, a term deposit is alone and you think of that line over three years, but you put your money away for three years and you put bullet back in three years. Fixed Income funds, in essence manifest for three years that they're trading every day. And so the volatility is not necessarily different than a term deposit. It's just valued differently. But if you traded your term deposit every day, today, we went into a bank and we set up a three year term deposit at 2%. And tomorrow, that bank was offering a three 3% term deposit for the same tenor, you tried to sell your 2% loan, who's going to buy it


Stefan Angelini

No


Adam Curtis

No one's gonna buy it. But conversely, if you'd locked in 2%, and the banks offering 1%, the next day, you're in the money.


Stefan Angelini

Yeah,


Adam Curtis

And that's really the challenge with fixed income. Everything can fit on these acts Stefan of what people call credit risk and duration risk. Some securities have no credit risk and lots of duration. That's like a US government bond. The risk is minimal that you lose money from the credit, but the interest rate risk is high because you're locked in 30 years with of interest rates and who knows what's gonna happen in 30 years. Conversely, you can have a short duration line that's got no interest rate risk, but you might be lending to a sub investment grade company and you've got a lot of credit risk. You don't really know. And if you don't know as I said, find out ask the questions and if you're not sure what the questions are work with guys like you will perpetual to find out


Stefan Angelini

That is exactly right. Need guys are fixed income. It's it's a very it's very despite thanks so much for coming on.


Adam Curtis

Absolute privilege and a pleasure.


Stefan Angelini

I record this conversation has opened up a lot of people's eyes to what the fixed income space is about. It's mainly about time and the risk you want to take with your money.


Adam Curtis

It is. It is. And it can be a really exciting asset class, get a right. And as I said, the other things in your portfolio matter less buy by the nature of you've got the predictability and the certainty that this asset class can provide. And as I said, I really caution against people chasing yield in an environment where risk is a little poorly price. Yields are low, that you want to think a little bit about what you expect from the asset class except the attributes rather than pursue a return because pursuing the return, may will introduce risk that you're not expecting


Stefan Angelini

Hundred percent, Mate. Thank you so much for coming on.


Adam Curtis

Thanks for having me here.


Stefan Angelini

Hope you really enjoyed this episode. If you got any more questions, feel free to leave a comment below. Other than that, we'll see you soon, Mate. Thanks a lot cheers really appreciate it.


Adam Curtis

My pleasure to talk. Thank you.


Stefan Angelini

Beautiful Alright,




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