Australian Ethical Fixed Interest WS (AUG0023AU) Report & Performance

The net of fees return of the Australian Ethical Fixed Interest Fund (Retail) for the September Quarter was -0.73% (-0.68% Wholesale), below that of its Benchmark, the Bloomberg Ausbond Composite Bond Index 0+. Yields closed the quarter higher, with the 10y bond rate rising 0.22% to 3.88%, but the path was non-linear and volatile.

In the month of July, yields fell as expectations of highly aggressive central bank policy (hikes of +1% at a single meeting for the Federal Reserve or 0.75% for the Reserve Bank of Australia) were unwound. Markets had been buoyed by the possibility of a slowing in the pace of rate hikes after Jerome Powell, the chair of the Federal Reserve suggested rate rises to July had seen the cash rate reach some members estimates of neutral. The 10y bond yield fell 60 basis points over July to 3.05%, which saw the fund and benchmark perform positively, up just over 3.3%.

In August however, this move reversed, as Fed speakers sought to counter the benign view, emphasizing the fight against inflation was ongoing and the cash rate would need to move into outright restrictive territory, with Powell later shifting language to highlight the probability of some “pain” yet ahead for households and businesses. The fund and index fell 2.5% as a result and fell a further 1.4% over September as yields rose aggressively, with the 10y marking a high of 4.1% before easing into the end of the quarter.

The fund remains neutral duration, with modified duration at 5.16 vs the index at 5.20, and the yield to maturity at 3.97%.

The return of the Australian Ethical Fixed Interest Fund (Wholesale) for the June Quarter was -3.91% net of fees. Retail units declined -3.96% net of fees. The fund benchmark, the Bloomberg Ausbond Composite Bond Index 0+ declined -3.81%. The June quarter continued the same themes that were present in the March Quarter, with yields rising considerably and credit spreads widening. Markets have moved to price an aggressive response from central banks to high rates of inflation, with expectations they will need to go beyond normalization of monetary policy to pre-pandemic settings instead targeting policy that seeks to restrict activity.

Government bond yields increased a further 77bps over the quarter, with the 10- year bond yield increasing to 3.57%, having increased 1.11% in the March quarter. In June in particular, the 10-year yield reached a peak above 4.1% mid-month, before easing back as market fears about a possible recession began to emerge.

The yield to maturity of the Fixed Interest Fund sits at 3.55% at the end of June, in line with the benchmark yield at 3.56%, having started the year more than 2% lower at 1.46%. When bond yields rise, the market value of those bonds declines, and the extent of that movement is determined by the duration of the bond (or portfolio). Through the calendar year to date the fund has been positioned with a neutral duration relative to the index, and at the end of June fund modified duration sat at 5.2.

March Quarter gross returns for the Australian Ethical Fixed Interest Fund were -5.98%, 0.10% behind the fund benchmark, the Bloomberg Ausbond Composite Bond Index 0+. After fees the retail units fell 6.10% and wholesale units fell 6.05%. The significant decline for the quarter follows a volatile quarter which saw bond yields rising at almost all points across the yield curve: the 10 year yield increased from 1.6% to 2.8%. This repricing of bonds quickly moved beyond the anticipated “normalization” of interest rate policy by Central Banks, away from emergency settings introduced at the start of the pandemic, and instead quickly shifted to pricing a more aggressive stance of policy where interest rates are expected to be increased beyond a “neutral” level to a restrictive stance in order to fight inflation. This followed comments from the US Federal Reserve at their March meeting, indicating a willingness to do what was required to restore price stability after US inflation exceeded 7% though the first reads of the year. When bond yields rise, the market value of those bonds declines, and the extent of that movement is determined by the duration of the bond (or portfolio).

Since the end of the previous quarter, the fund has been positioned with a neutral duration versus the benchmark with a portfolio average of 5.8. The overall yield to maturity of the fund increased from 1.44% at the end of December to 2.59% at the end of the quarter. The fund remains in a neutral duration position.

The net return of the Australian Ethical Fixed Interest Fund (Retail) for the quarter ended December 2022 gained 0.3% (Wholesale 0.4%), 0.1% behind the +0.4% return for the benchmark Bloomberg Ausbond Composite Bond Index 0+.

Bond markets remained volatile through the quarter, with the 10y yield rising 0.18% over the quarter to close the year at 4.05%, after originally seeing a low of 3.32% in early December. Where originally tentative signs of inflation having peaked came through in the monthly US data, a move by the Bank of Japan to loosen the tolerance band on their ongoing Yield Curve Control measures roiled bond markets and drove long bond yields sharply higher.

Markets ended 2022 trying to assess whether the Bank of Japan moves signaled central banks globally would remain hawkish into 2023, and/or whether Japan’s famously low yields might edge higher and encourage some funds invested offshore to return home, sapping demand and pressuring yields higher. With another US CPI print since year end again suggesting inflation continues to ease, since year end yields have retreated from their end 2022 level.

Domestically the RBA remains priced to hike again in the first half of 2022, with considerable uncertainty what direction rates might take in the latter part of the year. The fund remains with a neutral duration position as a result.

The Fixed Interest Fund performed slightly behind the benchmark index after fees over the September quarter, rising 0.8% (0.9% Wholesale Fund) against the 1.02% return of the Bloomberg Ausbond Composite Bond Index. In the wake of the economic disruptions caused by COVID-19, the performance of fixed income has been determined by the capacity and outlook for central banks and governments to continue to provide support.

Over the September quarter both the Governor and Deputy Governor of the Reserve Bank of Australia (RBA) have suggested that a further small cut to the official cash rate may yet be in the RBA’s toolkit. Towards the end of the quarter markets had begun to price in expectations that this cut would be applied to the cash rate, the target rate for 3- year government bonds under yield curve control operations and the rate at which funding is made available to banks under the Term Funding Facility. The Fixed Interest Fund retained its neutral duration position throughout the quarter, delivering in-line performance before fees.