Investment Management
Our portfolio construction for our underlying investment activities (with us and our investment manager(s)) is built on a simple reoccurring model below.
Our asset specific sectors for our investment activities are:
Cash
Our investment philosophy for cash and fixed interest is that we look at assets what we term “plain Vanilla” as they are managed with no enhancements and a shorter to medium duration. Our portfolios are an actively managed $AUD portfolio of high quality, short term, call deposits, cash equivalent securities, such as rated and unrated government and semi-government bonds, bank bills of exchange, corporate and asset backed promissory notes, and interest rate investment contracts (or equivalent).
There is no exposure to derivatives other than for hedging purposes and the relevant market return and to manage investment risk, is that solely of the underlying short dated portfolio.We operate the portfolio to provide stable income and preservation of capital through investment in short dated securities that provide a high level of liquidity and security. The portfolio maintains a very low risk and high liquidity characteristics. We aim to provide a return (before management costs) equivalent to the UBS Composite Bond Index plus % over a 3 year rolling period. The Investment Adviser will perform analysis and research on potential investments. We will consider, among other things:
- Economic factors that they believe are relevant to managing the portfolio;
- The historical performance of each potential investment;
- The historical volatility of returns and potential volatility in the future;
- Outlook for the investment and assessment of the risks to future returns; and
- If applicable, the credit rating of the underlying asset being proposed.
We will use internal and external investment advisers that will use their expertise to recommend a diversified portfolio of wholesale Australian bank bills and/or cash and cash style investments.
Corporate Debt
The global financial crisis (“GFC”) caused a short term setback, but it has also encouraged the increased use of corporate debt in the longer term. Several corporate collapses emphasized the low quality of some issues, and the general level of credit spreads increased sharply. Nonetheless, investors in higher quality issues did not suffer the 50%-plus losses which hit equity holders. This confirmed the perception of corporate debt as a lower risk asset class. On the supply side, the boards and management of many companies discovered the need to diversify their funding sources because their banks were not there when they were most needed. More recently, the Federal Government and the ASX Limited (ASX) have changed the regulatory regime in order to encourage the creation of listed interest rate securities for retail investors. At July 2010 the 87 interest rate securities listed on the ASX had a market value of $21.5billion and a daily trading volume of $294m, although the bank hybrids accounted for the bulk of value and volume.
The combination of these trends means that the Australian corporate debt market will continue to grow in size and complexity, and will increasingly require equity-like analytical skills to which most Australian fixed interest managers pay little attention. The poor performance of most fixed interest funds during the GFC was generally due to their exposures to high-yield debt which carried much more risk than the fund managers or the rating agencies understood. Credit analysis is reasonably reliable in identifying insolvency risk, but much less so in assessing how equity risks can affect the market value of corporate debt securities. The tendency of fixed interest managers to hug their benchmarks has caused sector returns to cluster around the index. As corporate debt now accounts for half the UBS Composite Bond Index, the median manager has a high exposure to equity risk. Although corporate debt is much less risky than equities, it carries much more risk than government and semi-government debt. Because Australia has not had a recession for 19 years, few fund managers or rating agencies have sufficient experience to identify and assess the probable consequences of the next recession. The typical fixed interest fund which tries to maximise each year’s alpha against a benchmark will suffer significant capital losses even if it manages to beat its benchmark. This is one of the main reasons why the Millinium is focused on capital protection and absolute returns.
The second key reason is that benchmark based investing does not suit most retail investors. A giant super fund which is offering a wide range of investment options to thousands of members aged from 25 to 65 can afford to think that good years and bad years will all average out in the long run. This approach is no use to a small investor who is trying to provide for his or her own retirement. The small investor knows that capital lost takes years of outperformance to make up. In practical terms this means that there are some securities which you shouldn’t own no matter how high the yield is. This is why Millinium uses its corporate debt option in its Multi-Strategy Income Fund C to include capital preservation as a fundamental component of its investment process.
Our investment style for this asset class is an absolute manager, which targets a post tax yield in the range 6% to 8%. If Millinium considers at any time that this return cannot be achieved in the coming twelve months, then we would consider that corporate debt as an asset class is over-priced and would recommend that fund investors switch to other asset classes. For example, credit spreads are wide at present, and we expect them to reduce, but a return to the low levels of 2006 and 2007 would trigger a switch to cash while we waited for a correction.Fixed Interest
Millinium teams up with Vianova Asset Management Pty Ltd ("Vianova") a 50% owned company of Australian Unity Limited to manage investments in this asset class. The focus is on delivering returns regardless of the performance of the broader fixed interest market (“index”). The allocation between the different types of fixed interest securities and cash is actively managed to take advantage of changes in the market. Other more traditional fixed interest managers tend to follow an index, which means the when the market performs negatively, the performance of those portfolio's will generally follow. We invest in a range of Australian fixed interest securities, including Government, corporate, bank, and other bonds, debentures, notes and other debt related securities, derivatives and cash.
Securities
We view that ASX listed equities can provide a reliable income stream for risk averse investors. Over the long term dividends from listed companies have been less volatile than capital gains, although dividends have accounted for a smaller percentage of total shareholder return. It must be emphasized that the investment process is specifically intended to exclude “high yield” securities because these are likely to carry an unacceptable level of risk. With that proviso, we look at stocks with above average yield that do not necessarily carry above average risk. In many cases they are simply businesses which have low growth prospects or low reinvestment needs (“cash cows”). Our investment philosophy assumes that, for a given level of risk and of total shareholder return, some stocks will generate more capital gains than dividends, while others will do the reverse – the investment process sets out to identify the latter class.