With interest rates at just 0.25%, Australian investors are earning an extremely low return from both cash and term deposits. And it’s likely to stay that way: cheap funding from the Reserve Bank of Australia (RBA), high deposit growth as households raise precautionary savings, and low loan growth all suggest that banks will maintain low rates for savings and term deposits for some time. In fact, savings rates are now well below the rate of inflation, eroding savers’ purchasing power. In other words, investors are currently being penalised for holding cash and not putting their money to work.

In this Q&A, portfolio manager Aaditya Thakur and co-head of Asia Pacific portfolio management Robert Mead discuss why investing in a diversified, actively managed short-term bond strategy can help investors enhance returns and preserve capital, while maintaining daily liquidity.

What is the Australian Short-Term Bond Strategy and how does it target its objectives?

Aaditya Thakur: PIMCO Australian Short-Term Bond Strategy invests in a broad fixed income opportunity set that can enhance return potential above cash investments. The diversified portfolio demonstrates a low correlation with other investments, especially equities, which may help reduce overall portfolio volatility.

The Strategy primarily invests in government, semi-government, corporate, mortgage and other fixed income securities denominated in Australian and New Zealand dollars, and can invest in high quality global securities where appropriate. It focuses on securities with high credit ratings and short maturities – typically three years or less – with the primary goal of preserving capital, whilst also aiming to earn yields higher than cash investments. This bias to short-term securities also gives it lower interest rate sensitivity than most core fixed interest portfolios.

With a track record of over 10 years, the Strategy has consistently demonstrated an ability to meet investor expectations of consistent income and capital preservation through all market conditions. As Figure 1 shows, the Strategy has outperformed cash and inflation since inception, thereby increasing clients’ purchasing power.

Figure 1: Strong performance against cash and inflation

How does the Strategy fit in an investor’s portfolio?

Robert Mead: PIMCO Australian Short-Term Bond Strategy is designed to fill the gap between cash investments and core fixed income funds. Many investors are holding significant quantities of cash or term deposits, reducing their ability to meet return objectives. The Strategy offers investors the ability to maintain liquidity and preserve capital, while also earning returns above the cash rate.

Unlike term deposits, the Strategy offers daily liquidity, an advantage for investors who want to be able to draw down their investments as needed. It provides greater operational efficiency than term deposits because it does not “roll off” and require regular reinvestment, and it provides quarterly distributions.

Why consider investing in the Strategy now?

Thakur: We believe the Strategy has three key advantages for investors:

1. Superior performance with lower risk than peers: A common approach to achieve enhanced-cash returns has been to rely on investments in Australian dollar-denominated credit and hybrids (which sit lower in the capital structure). This approach, which is used by many strategies in the Australian short-term space, can lead to higher volatility in returns.

In contrast, the PIMCO Australian Short-Term Bond Strategy aims to achieve its objectives by investing in a diversified set of risk factors, such as yield curve, rates, credit spreads, currency and volatility. This approach has led to greater consistency of returns and capital preservation. As Figure 2 shows, the Strategy has historically been successful in protecting against downside risk, and that includes during the volatility we saw in the first half of 2020. In fact, this period of market dislocation has highlighted the benefits of holding some duration, since this provided diversification during the most volatile months, and demonstrated why short-term bond strategies should not rely heavily on credit to drive returns.

Figure 2: Strong focus on capital preservation

 
2. Global diversification: Portfolios that include some investments outside Australia can help navigate more challenging markets. Because economic cycles and hence monetary policies are not in perfect alignment globally, diversification into global bonds may reduce the overall volatility of a purely domestic bond portfolio by giving investors exposure to countries with varying yield curves. In addition, it should help to reduce market-specific risk sensitivities so the Strategy is better positioned to provide more stable returns over time.
3. PIMCO’s approach to portfolio construction: Our Australian team combines expert local knowledge with the expertise of PIMCO’s global platform of 245+ regional and specialist portfolio managers and 90+ analysts, including 65+ global credit analysts.



PIMCO’s investment process has evolved over decades and been tested in virtually every market environment. It integrates insights from our Cyclical Forums, which anticipate market and economic trends over the coming six to 12 months, and the annual Secular Forum, which projects trends over the coming three to five years. These top-down views are complemented by bottom-up perspectives from industry sector specialists, who draw on our proprietary risk management technology, a highly skilled trading desk and four decades of industry-leading investment expertise to gain a deep understanding of securities across the globe and capital structure. The Investment Committee distils these insights into investment guidelines on factors such as growth, inflation, duration, volatility, sectors, countries and currencies.

What is our outlook for the Strategy and how are you positioning the portfolio should there be further market volatility?

Mead: PIMCO’s base case is that the economic recovery will be gradual and uneven, with many economies not returning to their pre-crisis GDP levels until 2022. Along with the base case, our outlook encompasses other potential paths, good and bad. In aggregate, while our base case assumes a gradual improvement in economic data, the risks appear skewed to the downside. However, it seems clear that policymakers are committed to further easing, even if better-than-expected economic indicators prevail. Given this backdrop, we expect interest rates to remain low for the foreseeable future.

This accommodation from policymakers is likely to have long-lasting implications for cash and term deposit rates. When considering their cash-plus strategies, investors will need to grapple with the twin complications of banks preserving net interest margins by passing on low rates and continued uncertainty around equity dividends.

We believe the PIMCO Australian Short-Term Bond Strategy is in a strong position to weather a wide variety of forward-looking environments. As mentioned above, the Strategy has a broad toolkit to access a variety of different return sources, rather than a concentration on a single risk factor to achieve returns.

The Strategy retains its defensive characteristics by maintaining a high average credit quality rating, along with a structural level of duration (sensitivity to interest rates), which should allow it to deliver returns if we experience volatility in risk markets. At the same time, the Strategy runs a structurally lower level of duration than typical core Australian bond allocations, so if interest rates were to rise in the future, investors aren’t overly exposed.

Find out more about the PIMCO Australian Short-Term Bond Fund.

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