Altius Sustainable Bond Fund (AUS0071AU) Report & Performance

Fixed-income markets were mixed in July as Central banks continued to increase interest rates. Although markets largely believe central banks are close to the end of their tightening cycle, the risk remains to the upside, driven by persistent core inflation. Domestically, rates curves steepened as the three-year rates fell 0.12% to finish at 3.86% while 10-year rates increased by 0.035% to finish at 4.05%. Portfolio interest rate risk was largely unchanged over July, finishing at 3.43 years.

The Reserve Bank of Australia (RBA) held rates steady at 4.10% at the July meeting with guidance remaining unchanged while noting “some further tightening of monetary policy may be required”. The Governor reprised the same language used at the April pause, “the decision to hold interest rates steady this month provides the board with more time to assess the state of the economy and the economic outlook and associated risks…” Overall the statement was balanced with the bank acknowledging that inflation had passed its peak but was still too high, labour markets were showing some signs of easing, particularly in the leading data such as vacancies and advertisements however unemployment is still at historical lows. Market reaction to the pause was muted with both three- and 10-years bonds rallying 0.04% while two further tightenings were priced over 12 months with September the preferred timing for the next move.

May was an eventful month for markets with concerns early about further US regional bank issues, further interest rate tightening by the US Federal Reserve, European Central Bank (ECB) and the Reserve Bank of Australia (RBA), negotiations around the US debt ceiling and data that pointed to inflation being stickier than expected. Over the month bond yields pushed higher across the globe. Australian three- and ten-year rates finished 0.37% and 0.25% higher at 3.37% and 3.61% respectively, with similar moves being experienced in the US with the two- and ten-year yields closing the month at 4.40% and 3.65% respectively.

The fund started the month with 2.25 years of interest rate duration before finishing the month with 3.09 years. The month opened with the RBA increasing the cash rate by 0.25% to 3.85% after a brief pause in April, which was contrary to market and most economists’ expectations. Forward guidance for further policy tightening was softened but the Board flagged upside risks around services inflation. This led to heightened volatility in bond markets as the short end of the yield curve initially sold off ~20bps on the decision, however, regained those losses a few days later.

Adding to the volatility, there was a fresh round of US regional bank concerns with First Republic Bank being closed and JP Morgan acquiring most of the asset, which was the third regional bank collapse in 2 months. In addition to this, equity prices of several other regional banks in the US fell significantly, driven by concerns about deposit outflows. The key driver of rates for the remainder of the month was headlines around the US debt ceiling which caused nervousness amongst investors and bonds subsequently traded with a bias towards higher yields, led by the US.

April was a fairly calm month for investment markets compared to the turmoil that surrounded March. Many of the key market volatility measures fell in April, including the US Treasury volatility index (MOVE) falling back to levels seen prior to the Silicon Valley Bank (SVB) collapse. This improved sentiment was also seen in equity volatility, with the VIX index falling to levels not seen since November 2021. Yield movements both locally and in the US reflected the improved trading environment. Australian three- and 10-years bonds traded in a 0.46% and 0.41% range respectively, well down on the March range of 1.06% and 0.84%, finishing the month largely unchanged at 2.98% and 3.34% respectively. While in the US, treasuries followed a similar path with 10 years finishing the month unchanged at 3.45%. The fund started the month with a duration of 1.84 years before reducing its underweight duration position to finish the month at 2.25 years. The Reserve Bank (RBA) delivered the first pause in the tightening cycle, leaving the cash rate at 3.60%.

There was still a tightening bias in the guidance with the board expecting that “some further tightening of policy may well be needed”. The bank cited lags in monetary policy, tightening of global financial conditions following the global banking problems, the softening of the monthly inflation print and a substantial slowing in household spending as the key drivers of holding rates steady. Markets had largely anticipated the pause which saw little market reaction.

March was a volatile period for global markets, with the key driver being concerns of a contagion in the banking system both in the US and Europe. Given this backdrop, sovereign bond markets were very strong, driven by flight-to-quality trades. Australian 10-year government bond yields fell 0.55% to finish at 3.30% while US 10- year treasury yields fell 0.45% to finish at 3.47%. Particularly notable was the extreme volatility in bond yields with an implied volatility of Treasuries as given by the MOVE index reaching its highest since the Global Financial Crisis (GFC) and some of the largest daily ranges seen in years. Equity markets were more mixed, with the ASX 200 returning -1.11%, however, the S&P500 continued its strong run, returning 3.5% for the month. The fund started the month with 2.87 years of interest rate risk before increasing to 3.40 years in the first few days of the month. The fund took profit on this long-duration position as yields dropped precipitously on the back of global banking concerns. By month end, the fund had reduced its total duration to 1.84 years as, in our view, markets had become overextended.

The Reserve Bank of Australia (RBA) delivered an expected 0.25% cash rate increase, the 10th consecutive rise to official cash rates, to 3.60%. The statement was less hawkish than the previous given the change of narrative from “further increases in interest rates will be needed over the months ahead” to a more open-ended “further tightening of monetary policy will be needed” (no reference to time). Market pricing now suggests interest rates have peaked at 3.60% and will start to fall from here, with an implied cash rate of 3.25% in 12 months’ time. Economic data locally continued to print relatively strongly with unemployment back to cycle lows at 3.5%, robust retail sales and Gross Domestic Product (GDP) data, and also inflation that is well above target, although the strength of the data took a back seat to the banking fears offshore.

After a positive start to 2023, most risk markets reversed in February. Globally, bonds had a poor month with Australian Government 3- and 10-year yields rising 0.42% and 0.35% respectively to finish at 3.60% and 3.85%. This move led to the Australian Treasury index giving back over half its January gains to be down -1.63%, while US Treasuries were down -2.41%. Investors ramped up expectations of monetary tightening throughout February as pessimism grew about inflation. By the end of the month, the US market had removed the expectation of monetary easing in Q4 2023, leading to the terminal cash rate of 5.40% from 4.60%.

This was a similar situation in the domestic market with the terminal cash rate moving from 3.78% to 4.31% by December 2023. The fund started the month with a short-duration position of 1.92 years before closing that position early in the second half of the month, adding value for the fund. By the end of the month, the fund held 2.87 years of duration, modestly long versus the benchmark.

January was a strong start for global markets with investors buoyed by several good news stories. A decline in gas prices of 24% saw several economists remove a European recession from their outlooks. The continued reopening of China meant investor sentiment turned positive on the Chinese economic outlook, but residual concerns did surface about the inflationary impact on the global economy. The ASX 200 returned 6.22% while the S&P500 had its strongest start since 2019 returning 6.3%. Sovereign bond markets were equally as strong with Australian 10-year Treasury yields falling 0.54% to finish at 3.32% with the Treasury index generating 2.93%, while United States (US) treasuries fell 0.37% to finish at 3.50%. With markets continuing to range trade over January the fund’s duration largely reflected these moves.

The fund started the month with 2.38 years of interest rate risk before being increasing to 3.70 years by the middle of the month. As yields pushed higher in the final week of January, we took the opportunity to reintroduce our underweight position. At the end of January, the fund held 1.90 years of interest rate risk. With the Reserve Bank of Australia (RBA) not meeting in January, attention turned to the data that would set the screen for the February meeting.

The release of a weaker-than-expected employment figure pushed rates to their intra-month low with the three-year bond falling to 2.97%. Full-time employment disappointed markets by printing negative 12,000, well below the consensus of plus 22,000, leading to a small uptick in the unemployment rate to 3.5% from 3.4%. The move lower in rates was short-lived following the release of the much-anticipated inflation report. Inflation surprised to the upside with headline at 8.4% Year on Year (YoY), well above expectations of 7.7%. Inflation momentum continued to build domestically in Q4 with 75% of the basket annualizing above the top of the RBA’s band. Of greater concern was the increase reflected domestically driven inflationary pressures which are more relevant for the RBA’s policy setting.

The higher inflation number pushed against some speculation that the RBA could pause at their February meeting and instead locking in a further 0.25% hike and a terminal cash rate of 3.75% by July 2023. Much of the strength in global bond markets was driven by softer economic data in the US and the growing speculation that the Federal Reserve (Fed) might be nearing the end of the tightening cycle. This view accelerated with the release of weak ISM services and manufacturing indices which fell into contractionary territory at 49.6 and 48.4 respectively and soft retail sales and industrial production numbers. US inflation data further supported the market’s view that we were past the peak inflation. Core inflation (excluding food and energy) gained 0.3% in December putting the annual rate at 5.7%, well below the peak of 6.6% in September 2022. While trending in the right direction, services sector inflation remains persistent.

Shelter costs remain a significant contributor although evidence in hand from the Zillow index indicates that new rents have peaked. Overall, the theme was that goods inflation is solved but services inflation will evolve over 2023. By the end of the month, the market expected the US Fed funds rate to reach 4.9% by July before falling to 4.40% by the end of 2023. This was in stark contrast to the Federal Reserve forecasts of a cash rate of 5.25% and no rate cuts expected until 2024.