Pimco's head of global wealth management – Australia, Peter Dorrian, tells Business Spectator's Alan Kohler, Robert Gottliebsen and Stephen Bartholomeusz:
- With hedging, Australian bond investors can make 6 per cent returns thanks to the rate differential with the US
Alan Kohler: Peter, a lot of people are saying that the great 30-year bull market in bonds is over. What’s Pimco’s view of that?
Peter Dorrian: Pimco’s view is that we have seen, yes, a significant reduction in bond yields in developed markets. I think it’s very important to make that distinction between developed and developing markets.
AK: I’m talking principally about the US really – 15 per cent bond yield in 1982, 2 per cent now, so a significant 30-year bull market.
PD: Yes. Which has been accompanied by significant reductions in inflation around the world. So, I think it’s eminently sensible that bond yields should be where they are in the US. I guess the question that follows from that, however, is: are they going up anytime soon? And our very strong view on that is no.
AK: Well, you have to say that because you’re selling a bond fund.
PD: Well, just because yields go up in one country in one particular part of the market doesn’t necessarily mean that it’s going to hurt portfolios because there’s a wide range of tools we have to use that can protect client in those sorts of events.
AK: But can you point to a period in history when bond yields actually went sideways for a long time? I mean before 1982 there was a 30-year bear market in bonds that started in 1946.
PD: Well, no I can’t, but our view is that the immediate future, as best as we can forecast – and anyone who says they can forecast more than five years out I think is just having a go – but the immediate future suggests to us that because growth around the world is going to be lower, interest rates will be kept lower for longer as a result of that.
Stephen Bartholomeusz: That’s the ‘new normal’ paradigm that Pimco refers to – a decade of very low growth.
SB: It’s not a very pleasant picture, is it, unless you’re a bond fund manager?
PD: Well, it’s not a very pleasant picture for anyone really because it implies continuing high levels of unemployment. You look at the US unemployment rate which has come down a little off the highs, from ten down to the early eights. That’s good news, but part of what has been driving that is two things; dropping the workforce participation rate and a large number of people somewhere around 40-45 per cent of people now who have been unemployed for a very long period of time who are losing their workforce skills and whose ability to re-enter the workforce in the future is going to be quite limited.
Robert Gottliebsen: But what we’ve seen in America… if you’re talking about a distant point of view, it’s stocks versus bonds and Goldman Sachs is saying stocks are what you should go for. You’re saying bonds.
PD: Well, on the Goldman thing overnight, I think everyone knows that equity trading volumes in the US have been very subdued, or brokerage has been very subdued, so anyone who needs that as a large part of their business is going to try to talk that up. And I think that was an interesting report, but somewhat predictable.
RG: Are you saying that Goldman are treating the share community like Muppets? Is that right?
PD: [Laughter] Your words Robert, not mine.
AK: But even if you’re right and bond yields aren’t going to start rising rapidly, they’re not going to fall any further – why would anyone buy bonds?
PD: As an Australian investor, which is I think what we’re talking to here, you’ve got to remember that most Australian managers will run global bond portfolios on a fully hedged basis, so that yes you’re investing in a 10-year treasury at the moment might give you two-and-a-quarter per cent, but you’ve got to remember that if it’s run fully hedged, you pick up that yield differential between the cash rates in the two countries. So, if we own a US treasury in a global bond portfolio for an Australian investor, the yield we’re actually delivering to that investor from that security is in the early sixes. So, yes, they seem low on a nominal sense, but you’ve got to remember from the Australian investor’s perspective, it’s quite a different story.
AK: Explain that. As an investor in Australia how do I get more than six per cent investing in US treasuries?
PD: It’s to do with the differential cash rates between the two countries. So, the US cash rate is in the zero to 0.25 range. Australia is at 4.25. So long as that differential is maintained, you pick up the yield difference between those two cash rates from investing offshore and managing it fully hedged.
SB: In relation to the bond market, public sector debt-to-GDP ratios around the world are at astronomical levels. How do you factor that into the outlook for the market given that we’re going to see huge amounts of refinancing over the next decade from the public sector?
PD: Well, the volume of issuance in the corporate sector in the last year or two has been quite phenomenal, yet it seems to have got away at very, very reasonable rates. So, I think the demand is still there. Now, Europe is a bit of a different case because they’re buying each other’s debt, but in the US the demand does not seem to be weakening at all, whether it be corporate debt or sovereign debt.
SB: Does that play into this discussion about the structural reweighting of exposures towards more defensive asset classes?
PD: Very much so. And a great example is the Ford Pension Scheme in the US have made a massive allocation and shift in that fund from a 45 per cent bond weighting to an 80 per cent bond weighting, just in the last couple of weeks, and the rationale for that, as described by the treasurer of Ford, was to try and just take the volatility out of that pension plan.
RG: To Australia now, your five-year bank deposit yield is getting close to six per cent. Would you say that would warrant self managed super funds for example to switch and downgrade their equity portfolios?
PD: Well, I think it’s going to take a little while for investors, particularly in that self managed super space, to accept the lower yield environment. They’re still in that 8-12 per cent type range in terms of returns which we don’t think we’re going to see for quite some time. A term deposit I think is a good component of investors’ portfolios, particularly self managed super funds. All we’re saying is that it shouldn’t be the only exposure you have to debt markets because the big thing with a term deposit is that you’ve got no control over the liquidity if you need that money back for some reason, and also you’ve got quite significant reinvestment risk because who knows what the environment is going to end up in five years’ time. You might be getting a good yield now, but we could be in a very different economic environment, a very different interest rate environment you’ve got no control over if that’s your only exposure to fixed income markets.
SB: Apart from the fixed interest funds, we’ve seen the nascent development of a listed corporate bond market in Australia. Are you supportive of that?
PD: Very much so. Whilst you’ve got some concentration risk if you’re just in that one, single corporate name and some obvious credit risk as a result of that, anything that can increase the level of exposure and understanding of the bond market in Australia we think would be a good thing for investors.
AK: The foreign ownership of Australian government bonds is up to 76 per cent or so from about 25 per cent not that long ago. How much of that is Pimco?
PD: Well, all of our money in Australia is managed on behalf of Australian investors… [but] there are three things we do offshore. One is any global fund run out of any country in which we operate will have an Australian component because we’re favouring Australia as a market at the moment. Two, we’ve just launched an ETF in the US market which is purely Australian bonds. And three, we have a fund managed for Japanese investors out of our Japan office which exclusively invests in Australian bonds which has been the most successful bond fund in Japan for the last five years. It’s raised about three-and-a-half billion dollars. So, there’s a lot of interest in Australian bonds if they yield.
AK: So, you’d like the Australian government to keep running deficits, wouldn’t you?
PD: Well, the supply at the Federal level may or may not diminish. We’ll see how that comes out in the next election. But remember, you’ve got the stock at the state level as well. Many of the state governments have decided that debt isn’t such a bad thing after all, and New South Wales and others are starting to look at different parts of the bond market to try and help fund their infrastructure.
AK: So, do your ETFs invest in state government bonds as well as federal?
PD: Our offshore ETFs? Absolutely, yes.
RG: Peter, our biggest borrowing offshore in Australia comes from our banks and they’re getting squeezed in terms of offshore borrowing. Have you thought of overseas funds to invest in our bank loans?
PD: Well, about three and a half years ago we talked to investors about a strategy where we would be exclusively owning bank debt and we had quite a number of clients who were quite interested in doing that. I guess that waxes and wanes with offshore investors’ view of our banks and one thing you’d have to say at the moment is that there’s quite a wide difference of opinion between Australian investors’ view of our banks and offshore investors’ views, and it’s largely got to do with what you think is going to happen with the Australian property market. Even my colleagues in the US look at the Australian property market and say it’s the most overvalued property market in the world. To be honest, it’s a serious bubble. Now, that’s not necessarily the view of us here in Australia, and not just because we own Australian property. They’re looking at all sorts of different metrics that they use to standardise property markets around the world and say that they think Australia is seriously overvalued in the residential space.
RG: So Australian banks are caught in this crossfire where the overseas people just don’t like the look of the Australian bank balance sheets and are very reluctant to invest in Australian bank debt unless it’s a very high rate.
PD: Well yeah, but also there’s a lot of competition for bank funding around the world at the moment as well. Australian banks are competing with all sorts of other banks in all parts of the world. But you’re right, there is an emerging view that because the big four Australian banks are so tightly levered into the domestic property market that if there was to be some more severe correction in the property market, that may have an impact on bank balance sheets.
AK: The problem is that the global investors are worried about the Australian property market which means that they’re worried about Australian banks?
PD: Correct. Now, it’s interesting that you say that because most Australian banks… the average LVR across the RMBS portfolios is still in the 50s, so you know there could be quite a significant fall in Australian property prices before we’d really see any severe impact there, but it’s the perception that counts at the moment and there’s certainly that perception.
AK: It’s to some extent self fulfilling – if the interest rate the banks have to pay in the wholesale market keeps going up, that will have a damaging effect on the property market in Australia.
PD: Well, ultimately that’s true, yes.
RG: Of course, if the government was to guarantee the banks, it would make a huge difference, wouldn’t it?
PD: We’re not saying we don’t invest in Australian banks. We hold quite a lot of Australian bank paper in our portfolios. But simply transferring the risk from the banks to the government? Then people start looking at the government just as they are in Europe, just as they are in other parts of the world.
AK: You can count this taxpayer out, Bob. [Laughter]
SB: In Europe at the moment, all this liquidity has been poured through the eurozone. Is that a solution or is the crisis dormant in a sense?
PD: The crisis is there and will be there until there is some concrete and widely accepted plan to reduce the overall level of debt. Just moving it around which has been done for the last two or three years is clearly not the answer. Our CEO, Mohamed El-Erian, keeps on saying it’s just kicking the can down the road further and further and further, and that’s all that’s happening. It’s interesting you look at the UK which is probably the first country to put in place quite significant austerity measures to try and pull the fiscal position back into place and then ultimately try and get the debt down. The market has reacted well to all of those plans and proposals in terms of how they’ve treated UK interest rates. So for us there’s a bit of a template there that the rest of Europe could look to, to actually get serious about this as opposed to just move it around.
RG: So, you think the crisis is still ahead of us?
PD: We have a view at the moment that there is the prospect of what we call this bi-modal situation where everything looks a little bit calm at the moment, but there needs to be further resolution.
SB: And how would that play out? Where’s the start, the next wave?
PD: Well, it starts with a real default, an acknowledged default increase and the need then for Greece to think about how it exits the EU. That I think would prove very unsettling to markets around the world.
SB: And that would then spill into Spain, Portugal, Italy and Ireland?
PD: One of the interesting things about the EU when it was formed was there wasn’t really any break up mechanism enshrined in terms of ‘okay if a country is going, how do we get it out?’ What do we do with the currency? We’ve been thinking a lot about if Greece needs to leave the EU. I mean you’re going back to the things we haven’t seen for a very long time; Ring-fencing the currency, capital controls, no movement of people because they’re all still holding euro and obviously they can’t continue to do that. They need to move to a different currency. So, there are a lot of things to think about were that to occur. Now, the ECB has been very successful at putting that off, however there are a few tricky clouds on the horizon. Greece has got an election coming up. There’s no guarantee that the party or people that are elected there are going to be sympathetic to further austerity for Greece. And the other thing is of course that Greeks are now starting to leave the country. In 2010 there were 50 applications from Greeks to migrate to Australia. In 2011 there were 12,000. That’s just Australia.
AK: I didn’t know that. 12,000? Wow.
SB: Disconcerting… for the Greeks.
RG: Tell me, to what extent did it set back your group when you miscalled the US treasuries back some months ago and you moved out of those areas and it was a wrong call? How has that affected your group?
PD: That decision was really confined to one fund which was a mutual fund that we market in the US called the Total Return Fund. It really hasn’t had a very significant impact for two reasons. One, because we were very public about admitting that we got that wrong. And two, we were very public about explaining the reasons why we got that wrong because in this sort of environment our primary responsibility in the management of defensive assets is to ensure that we have the ability to return our clients’ capital, to protect that capital. Secondary is an obligation to get a good return on that capital. And that’s just because of the sorts of markets we find ourselves in at the moment. And I think people understood that the rationale for us doing that was because we were trying to protect from what we thought was a serious risk in that market. Now, we had a bit of blip in terms of impact on the fund flows into that fund in the US in the last two quarters of last year. Performance has come back quite strongly in the first part of this year for that fund and flows seem to have returned to more normal patterns.
AK: Well, let’s leave it there. Thanks very much, Peter.
PD: Okay. Thank you.
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