Today marks the official launch of a new Australian based fund manager – Fortlake Asset Management.
Fortlake brings together some of the best investment minds in Australia – brain child of ex UBS executive Christian Baylis and supported by “Australia’s Warren Buffet”, investor Alex Waislitz, as a major shareholder, together with Fund Income, a new fund incubation business wholly owned by Cashwerkz (ASX:CWZ).
Baylis has a long list of impressive credentials and says he has been testing his strategies for the last ten years. As a testament to his credentials the fund manager already has $150 million in funds under management, and is targeting $1 billion plus, which if successful will make Fortlake one of the few Australian asset managers not owned by a big bank.
Alex Waislitz said, “We are excited by the opportunity to be working with Christian and his team. He is a best in class manager with a clearly demonstrable track record. In the current low interest rate environment, the performance of a fixed income manager is more important than ever.”
Fortlake has four funds on offer with two available to retail investors which include:
- Real Income* – Target RBA cash rate + 3%, invests in investment grade securities and manages inflation risk
- Real Higher Income* – Target RBA cash rate + 5% also invests in investment grade securities but lower down the capital structure including Tier 2 and Tier 1 hybrids
- Real Opportunities Fund – Unconstrained and absolute returns above inflation. Principally defensive, high grade portfolio that can invest up to 25% in offshore government bonds and opportunistically invest in up to 15% in corporate bonds
- Sigma Opportunities – Target RBA cash rate + 8-11%, seeks distressed and dislocation opportunities with high returns
*Available to retail investors, pays monthly income
I was fortunate enough to interview Baylis, who provided some excellent insights into the current market.
Do government bonds have a role to play in portfolios?
Government bonds do have a role to play, especially in the inflation-linked market. I believe the risk premium on these assets is akin to a credit spread. This is the best stage in the cycle to invest in inflation-linked assets. Nominal yields (fixed bonds rate) are unlikely to go deeply negative but real yields (purchasing power of funds) have gone to -5% to -10% looking back over time to the 1940s.
So, I wouldn’t be investing in the nominal market but the time is right to invest in inflation-linked government bonds. There is lots of possible appreciation to come if the call is right.
Has the correlation between bonds and equities changed?
Bonds were negatively correlated to equities. But bond managers haven’t seen the co-integration of the asset classes which bring them together in a market in crisis.
The question becomes will the correlation stay or will it go back to what it was?
Nominal (fixed rate) bonds won’t protect your portfolio. Holding fixed rate government bonds won’t give you the benefit of capital appreciation anymore, in a zero interest rate environment.
Investors need to get creative to manage risk. They need a proper hedge and non correlated returns, real yields and capital appreciation.
What do you see as the downside risks that investors need to be aware of?
The risks of disinflation and deflation are key downside risks.
Australians are overweight property, which tracks inflation, and if property prices (inflation) fall, then the equity in their properties also falls. Furthermore, they also can’t inflate away the debt over the longer term.
So, a shortfall in inflation is like the black death in financial markets and people’s finances. They typically don’t see the short term danger. If inflation targets, which are anchored at 2-3 per cent are let go and inadequately defended, there is a real risk they become unmoored and fall substantially below the target objective. This creates debt deflation and risks in the economy, and risks for financial intermediaries become ever greater.
[Also read: Major Banks Prove Resilient But Risks Are Mounting]
You have this megatrend of declining real rates over more than 700 years that started in the 1300s with a 1-2 basis points decline per year. This flies in the face of secular stagnation (an economy with chronic lack of demand). The trend is still in place and we are well within the bounds of a normal level of volatility around that trend.
But for government bond yields out 30-years to 2050 are pricing an implied level of inflation of around 1.70%. That goes against the mega trend as real rates need to go deeply negative to push that level of implied inflation up toward the central point of the RBA’s target and it’s just not going to happen, given the current level of policy accommodation. Policy changes to date have helped but it’s “time to throw the kitchen sink at inflation.”
The RBA mandate to target 2-3% inflation hasn’t changed. It’s effectively locked in by law. It doesn’t take much for the central bank to lose credibility but it’s very hard to win it back if they don’t do all they can to meet the inflation target. This happened to the Bank of Japan in the 1980s and 90s.
The inflation target is a signaling mechanism. I am slightly critical in the way the RBA has moved. If it’s too slow and shows reluctance to get ahead of the problem, the market will sense that and won’t believe the bona fides of its disinflation fighting credentials.
Investors need to hedge inflation even though it’s at century lows. The time is right, as we now face a multi decade battle with disinflation. The risk has been priced now and it’s time to change tack.
Should households lock in fixed rate mortgages now?
Households with floating rate mortgages have benefitted and protected themselves. But now is a good time for borrowers to lock in low interest rates. There is very little nominal rate accommodation the central bank can provide. The asymmetries have now flipped in my view and the potential for inflation to now pick up on supra secular basis should now be considered, holding fixed rate liabilities gives you access to the asymmetry I am thinking of.
The best way they can now deflate mortgage debt is to lock in interest rates while they are very low and hope inflation rises. There is basically not much to lose by taking this approach. I can only say this with some degree of confidence, because the RBA has said they don’t want negative nominal rates.
Think of a scenario where we have zero interest rates and 10% inflation (not that I’m saying it will go that high). You then have -10% – a negative real yield. However nominal rates will go substantially higher in that scenario, albeit an extreme one.
Fortlake funds’ strategy invests in inflation linked government bonds, as well as inflation overlays attached to corporations, as we don’t want to give up the income available in this market.
How do you incorporate ESG into your portfolio?
Unless you are given a direct mandate for an ESG portfolio, the best way to manage ESG as a fund manager is to make sure the risk is priced into the investment.
Take AMP as an example. A few years ago, it would have had a high ESG rating being a good ESG candidate. Now investors are turning away from the company and don’t want to invest, but ESG risk is appropriately priced and investors are well compensated. You just want to make sure the risk is priced right.
Fortlake Asset Management – Board of Directors
- Dr Peter Higgs – Chairman
- Dr Christian Baylis – Managing Director
- Alex Waislitz or Martin Casey (Thorney) – Major Shareholder & Non-Executive Director
- Dr Kylie-Anne Richards – Executive Director
- Jon Lechte – Non-Executive Director
Fortlake Asset Management – Board of Advisers
- Peter Coad – Non Executive Director & Chair of the Risk Committee
About Dr Christian Baylis – Founder and Chief Investment Officer
Christian is a highly regarded Australian-based manager with broad experience across global fixed income and derivatives strategies, having worked previously at UBS Asset Management and the Reserve Bank of Australia (RBA).
Christian managed in excess of $8 billion AUM and was the lead Portfolio Manager in the UBS Australian Fixed Income team for the UBS Cash Plus Fund, the Insurance and ALM book of business and ran a complex methodology of overlay strategies for large cross-border liability clients. Christian was also a member of the UBS Global Multi Strategy Committee and was appointed as the Australian representative for the UBS Global Dynamic Fund, the core global unconstrained Fixed Income offering for UBS Asset Management.
Christian was Head of UBS’s Derivative Strategy, Inflation Linked Assets and Credit Trading across the Australian Fixed Income business, managing more than $26 billion. This role incorporated oversight of Sector Strategy – incorporating Semi-government and Sovereign Supra National Agencies (SSAs) and the development of the associated ESG framework for these assets. As a member of the UBS Global Multi Strategy Committee, Christian was actively involved in the macro analysis and research of fixed income markets for the global Fixed Income business.
Christian joined UBS Asset Management in March 2011. Whilst managing the UBS Cash-Plus Fund from March 2011 to May 2020, Christian obtained the only ‘Highly Recommended’ rating from Zenith for consecutive years 2017 – 2020 for the Short-Term Credit category. Prior to this, he was a Senior Analyst at the Reserve Bank of Australia (RBA), managing the Bank’s investment portfolio, liquidity and liability profile. Prior to his role at the RBA, Christian worked for Standard and Poor’s, as a Rating Specialist conducting rating assessments and research.
Christian has a PhD in Econometrics from Monash University and was a recipient of the distinguished Exceed First Class Honours award, receiving a perfect GPA. Christian won the Australian Postgraduate Scholar Award at both University of New South Wales (UNSW) and the University of Sydney (USYD) for his work in the Econometrics field and was a visiting scholar at Monash University in the Econometrics faculty. Christian was also the recipient of the prestigious Capital Markets CRC PhD Scholarship where his work focused on alternative methods of inflation modelling, probability density functions and option implied distributions.
