TelstraSuper’s fixed interest team had a stellar year last year, but they are keeping a close eye on the direction of inflation. There could potentially be some upside surprise ahead, causing volatility in markets, Zoran Josic says
On 18 September 2024, the US Federal Reserve cut the target range for the federal funds rate for the first time in four years. The Fed reduced the rate by 50 basis points to a range of 4.75 to 5 per cent.
The cut was interpreted to be mainly on the back of concerns over the labour market, but at the same time, the Fed was positive on the state of the economy and the direction of inflation.
“The Committee has gained greater confidence that inflation is moving sustainably toward 2 per cent, and judges that the risks to achieving its employment and inflation goals are roughly in balance,” the Fed said at its September 2024 Federal Open Market Committee meeting.
Zoran Josic, Head of Fixed Interest, Cash & Currency at TelstraSuper, says the market is pricing in another 9 rate cuts [of 25 basis points], potentially bringing down the rate by another 225 basis points by the end of 2025.
But inflation might not follow a straight trajectory and there could be some upside surprises along the way, he says.
If we get a few inflation surprises on the upside, then this could really cause a lot of volatility. Because I think it would be fair to say that the Fed is currently somewhat comfortable with the trajectory of inflation
“If we get a few inflation surprises on the upside, then this could really cause a lot of volatility. Because I think it would be fair to say that the Fed is currently somewhat comfortable with the trajectory of inflation,” Josic says in an interview with [i3] Insights.
“Their concerns lie more around employment and unemployment. But we will see how they react if we see a couple of surprises,” he says.
Yet, the prospect of further rate cuts means fixed income investors need to be careful about taking on duration. In fact, the coming period might be more conducive for equities.
“You’ve got to think twice if you want to be long duration, long bonds, when you have 9 [cuts priced in]. And my team’s view is that this is pretty much as good as it gets for the equities markets, because there won’t be another push higher, given the extent of these cuts priced into the markets.
“The earnings will be a driving force, rather than lower for longer on the rates side,” he says.
Drivers of Portfolio Performance
Josic and his team had a strong year with their fixed income portfolio. According to data from research house SuperRatings, TelstraSuper’s Diversified Bonds and Credit option returned 4.72 per cent over the 12-month period to 30 June. In comparison, the industry median for this type of investment was just 3.18 per cent.
As might be expected, returns from its credit allocations were a key driver of performance, but Josic says this wasn’t the only factor in last year’s returns.
“I would say we pretty much had a trifecta. It was our asset allocation within the option, which worked really well, followed by strong alpha from almost every manager, which doesn’t happen often,” he says.
The main levers are duration and credit, and we had a strong conviction on the credit side rather than the rate side, even though we could see inflation persisting. So our overweight to credit was a lot more accretive than our duration management over the past three years
“We also made some tactical changes to our overlays. We have a number of overlays, which we use at various levels and those overlays also added a decent amount of alpha,” he says.
Josic doesn’t want to give too much away about how these overlays are implemented, as this is somewhat sensitive information from a competitive point of view. Besides, credit was a much stronger driver of portfolio performance than overlays, he says.
“The main levers are duration and credit, and we had a strong conviction on the credit side rather than the rate side, even though we could see inflation persisting. So our overweight to credit was a lot more accretive than our duration management over the past three years,” he says.
“If you think about credit, it’s a single term, single umbrella, but obviously it includes a lot of different sleeves: from high beta, securitised, structured, to low beta, things that are investment grade. Our strong overweight to credit worked out incredibly well across the board,” he says.
Private Credit
Josic and his team look after the liquid, publicly traded holdings of the fund, which includes external managers but also a number of internal strategies.
“My initial mandate was to basically internalise as much as possible when I joined 13 and a half years ago,” he says.
“The hybrid model, which we currently have in place, is becoming a lot more common, especially amongst the bigger players. And one of the key benefits, I would say, is keeping the finger on the pulse, knowing exactly what’s topical, having that engagement with the banks and the sell side,” he says.
The more illiquid holdings, such as private credit, are managed by the alternative assets team, under the leadership of Kate Misic, although Josic does have some private credit in his portfolio through external managers.
“My bias is towards more liquid assets, structurally speaking, but we do have a little bit of private credit in our fixed income allocation. That’s at a margin, but it was definitely accretive to the returns,” he says.
Private credit is a bit of a gold rush. One potential concern is that this segment hasn't really gone through a proper cycle, so it's still in its infancy. It's very challenging to get any default restructuring data
Private credit has attracted a lot of capital in recent years, on the back of double-digit returns, and Josic is keeping a close eye on this space.
“There’s a lot of money chasing private credit, and I guess discipline is critical in this space,” he says.
“There are a lot of boutiques on the smaller side out there which are deploying capital without too much of a track record, so to speak. And then on the larger side, you know, quite kind of aggressive bidding because there’s just so much capital to be deployed. We are mindful of that.”
There could even be a correction in this asset class, Josic says.
“A correction in private credit might be possible, but the timing of that correction is completely unknown,” he says.
“Private credit is a bit of a gold rush. One potential concern is that this segment hasn’t really gone through a proper cycle, so it’s still in its infancy. It’s very challenging to get any default restructuring data.
“There’s a lot of pretend-and-extend, a lot of zombie companies in there,” he says.
TelstraSuper recently announced it is in merger discussions with Equip Super.
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