CFS W Strategic Cash (FSF0075AU) Report & Performance

The change in monetary policy settings in Australia had a meaningful influence on the Fund’s performance in 2022. At the beginning of the year – when official cash rates were close to zero – the Fund was struggling to generate any positive returns at all. The Fund returned 0.94% in the December quarter, however, benefiting from much higher bank bill yields. Pleasingly, returns were ahead of the bank bill benchmark over the quarter.

The improved performance in recent months enabled the Fund to appreciate by 1.48% in the calendar year as a whole. Again, this was ahead of the return from the bank bill benchmark.

Annual returns were well below the 4%+ annualised returns since the Fund’s inception in the late 1990s, but represented a marked improvement from the previous two years. More importantly, given the likelihood of further rate hikes as policymakers continue to battle inflation, the Fund should continue to generate reasonable returns in the year ahead. At the end of December, the Fund’s prospective yield was nearly 4%; almost back in line with the long-term average.

Net of fees, the Fund returned 0.5% in the September quarter, slightly ahead of the 0.4% return from the bank bill benchmark.

Sharply rising bank bill yields, owing to increases in official interest rates, fed through to improved returns from the portfolio. This was a welcome development following the past two years or so, where emergency low interest rates following the Covid shock resulted in extremely low returns from cash funds.

The widening of residential mortgage backed securities (RMBS) margins slowed during the quarter. Whilst a detractor from the Fund’s performance in recent months, RMBS holdings are well positioned to contribute to the Fund’s total yield in the coming months, assuming credit markets stabilise.

The Fund returned 0.0% in the June quarter, net of fees. This was broadly in line with the 0.1% return from the bank bill benchmark. Spreads on residential mortgage backed securities (RMBS) continued to widen, which hampered performance and resulted in adverse mark-to-market valuations in the Fund’s RMBS exposures. Positively, the Fund’s RMBS holdings should provide a significant return enhancement going forward owing to higher reference rates and wider trading margins. Accrual on holdings in term deposits is increasing too, providing support to overall performance.

Officials have indicated that policy settings will continue to be tightened in the months ahead. In turn, higher bank bill yields should meaningfully improve the income generation of the portfolio, as underlying investments will earn higher yields. Policymakers have consistently suggested wage price inflation is an important consideration in their policy deliberations. With that in mind, it was interesting to note that wage growth in the March quarter was below consensus expectations and, more importantly, below current inflation levels. This suggests official borrowing costs in Australia might not be raised as high as some forecasters are anticipating.

Moreover, Australia has a high level of household debt relative to most other developed countries. The economy is therefore more sensitive than some others to rising interest rates and mortgage repayment costs. Again, this suggests the Reserve Bank of Australia might not be required to raise official cash rates as substantially as some other countries. Consumer confidence levels in Australia are already subdued and any further increases in borrowing costs might affect discretionary spending. Central bank officials must be mindful of this and will likely be wary of triggering a recession by raising borrowing costs too high and too quickly.

The Fund declined in value by 0.03% over the quarter, a return that was slightly behind the 0.01% return from the bank bill benchmark. Spreads on residential mortgage backed securities (RMBS) continued to widen, which hampered performance. In fact RMBS spreads have now widened in four of the past five months, resulting in adverse mark-to-market valuations in the Fund’s RMBS exposures and, in turn, negative returns from the portfolio. The moves in the RMBS market largely tracked volatility in the broader Australian credit market, where spreads have risen owing to the prospect of rising borrowing costs and escalating geopolitical tensions. Assuming margins stabilise, the RMBS holdings will provide a significant return enhancement given both the expected higher reference rates and trading margins. Thankfully, accrual on the Fund’s holdings in term deposits and Negotiable Certificates of Deposit provided some support to overall performance.

The Fund appreciated by 0.03% in January, a return that was 2 bps ahead of the bank bill index benchmark. Accrual on the Fund’s holdings in term deposits and NCDs provided support to overall performance. Following two months of widening, spreads on residential mortgage backed securities were more stable over the month – accordingly, this allocation did not have a meaningful influence on performance in January. Some of the Fund’s excess cash could be deployed in the residential mortgage backed securities market in the months ahead. Collateral performance remains excellent, with repayments being supported by low unemployment, still relatively low mortgage rates, and a rebounding economy. Trading margins are 20-30 basis points wider than the lows in the second half of 2021, and should provide suitable risk-adjusted returns. With this in mind, we await the restart of primary market activity in February. There were no changes to strategy or overall portfolio positioning during January. The aim is to identify and source investments with prospective yields over and above bank bill swap rates. To minimise risk and with capital preservation in mind, there remains a focus on the quality of all securities held in the portfolio. All are AUD-denominated, and are highly rated by ratings agencies as well as our own internal credit analysts.

The Fund continued to eke out modest gains in the June quarter, rising in value by 0.1% net of fees.

The steady positive return maintained the Fund’s favourable performance track record in the FY21 year. The Fund appreciated by 0.3% in the year as a whole. Despite being well below the Fund’s historic annual returns for the 20+ years since inception, this was a creditable performance relative to the benchmark. The Bloomberg AusBond Bank Bill Index returned just 0.1% over the year; comfortably the lowest annual return on record. FY21 was a very unusual period for Australian money markets – probably the strangest since we started managing assets in this sector in the early 1990s – butpleasingly we were still able to identify investments offering yields over and above bank bill swap rates. Being able to source these securities and blending them together within a diversified portfolio helped drive performance and maintain the Fund’s favourable long-term track record.