A Smart Alternative

 

Introducing the Ardea Real Outcome Fund and ActiveX Ardea Real Outcome Bond Fund (Managed Fund) (ASX: XARO)

Doors, Choices, Choose, Decision, Opportunity, Choosing

 

With the RBA recently cutting the official cash rate twice to a record low levels of 1.00% p.a., for many investors the need to consider other income sources to maintain current levels of income has increased. As such, the Ardea Real Outcome Fund (ARO) or its related ASX-quoted active ETF launched in December 2018, the ActiveX Ardea Real Outcome Bond Fund (Managed Fund) (ASX:XARO), may be smart alternatives for those investors to consider as term deposit (TD) rates decline in line with falling cash rates. But first, it’s important to be clear that ARO and XARO are not cash or TD substitutes. This is because neither ARO nor XARO benefit from the government guarantee for bank deposits. Instead ARO and XARO are actively traded fixed income strategies which are intended to deliver a return higher than cash and TDs but may experience negative monthly returns and are subject to a range of other risks. For these reasons, ARO and XARO are not suitable to replace ‘at call’ cash products or where the investor is uncomfortable with the change in risk profile. That said, with current advertised one- and two-year TD rates from the big four Australian banks dipping below 2.00% p.a.1, ARO or XARO may be suitable investment alternatives for investors looking to invest surplus cash over a longer investment horizon and can tolerate a higher risk level than TDs. ARO seeks to strike the right balance by offering the potential for higher medium-term returns than TDs2, but less risk than many other income seeking investments3. A minimum 2-year time horizon for an investment in ARO or XARO is recommended.

ARO’s volatility has been consistently lower than risk levels experienced by many common Australian income asset classes. Commonly used income alternatives like dividend paying stocks, bank hybrids, mortgage backed securities and credit investments may provide higher returns than TDs but can also experience significant volatility in adverse environments, with hybrids and credit investments also being subject to greater liquidity risk.

For investors willing to accept a higher level of risk than cash or TDs, including the risk of modest short-term volatility and of capital loss, ARO can be a smart alternative for surplus cash invested in low return bank deposits.

The following characteristics of ARO and XARO are relevant to consider as an alternative for medium term surplus cash:
✓ historically low volatility returns vs. other income-generating asset classes (see chart above).
✓ daily liquidity as ARO processes redemptions daily and XARO investments can be sold on market at any time (0.025% bid/offer spread for unit trust or on-market spreads for active ETF vs. the typical break costs for TDs if redeeming prior to maturity).
✓ smooth quarterly distributions with minimal administration (vs. continually rolling TDs).
✓ returns independent of the direction of interest rates from Ardea’s ‘relative value’ investment approach (TD returns typically decline as interest rates fall).
✓ low correlation to equity and bond market fluctuations offers portfolio diversification benefits.
✓ low credit risk (portfolio is primarily invested in ‘AAA’ and ‘AA’ rated government bonds and excludes credit investments).
✓ low interest rate risk (portfolio is managed with close to zero interest rate duration)
✓ no FX or emerging markets risk.
✓ ‘risk-off’ strategies that are designed to profit in adverse environments and therefore offer the potential for additional returns when equity and broader fixed markets are more volatile.

 

Why choose ARO/XARO over conventional fixed income funds?
Conventional fixed income funds typically have only two choices for generating higher income:

  1. Buy longer dated bonds and so take more interest rate duration risk, (i.e. so there is the potential for capital losses if bond yields rise)
  2. Buy credit investments (e.g. corporate bonds, loans, etc.) and take more credit risk, with the potential for capital losses in adverse market environments
    In our opinion, both these choices currently carry more risk for less return and may no longer be as defensive as previously assumed. The following articles provide further insight:

In our opinion, both these choices currently carry more risk for less return and may no longer be as defensive as previously assumed. The following articles provide further insight:

The unfavourable asymmetry of duration risk
Compensation for credit risk is poor
Bonds don’t always diversify equity risk

By contrast, each of ARO and XARO offers another alternative that has low interest rate duration risk, no credit investments and returns that are independent of declining interest rates and bond yields. It does this by combining Ardea’s unique ‘relative value’ (RV) investment approach, with ‘risk-off’ strategies that are designed to profit in adverse market environments, to target low volatility fixed income returns, irrespective of broader bond and equity market fluctuations. While ARO’s investment approach is unique, its portfolio is made up of the same high-quality government bonds and cash investments that conventional defensive fixed income strategies typically use. What’s different is the way Ardea extract returns from these securities and the wide range of risk management strategies used. The resulting return profile exhibits low correlation to equities, government bonds and credit markets, while aiming to deliver returns that are higher than cash rates with low levels of volatility. The following articles provide further insight: In our opinion, both these choices currently carry more risk for less return and may no longer be as defensive as previously assumed. The following articles provide further insight:

There’s more to fixed income than just buying bonds
Rethinking fixed income in retirement
Market inefficiency is a growing opportunity in fixed income

Combining uncorrelated RV return sources with risk-off strategies allows ARO and XARO to offer the potential for higher returns in more volatile environments, when conventional investments may incur losses. This type of return profile can be a useful risk diversifier when added to a broader investment portfolio.

These characteristics were evidenced in ARO’s performance throughout the market volatility experienced in 2018, as shown in the charts below. ARO’s returns remained positive and smooth through the bond and equity market volatility experienced in 2018 and early 2019.

 

 


Unless otherwise specified, any information contained in this publication is current as at the date of this publication and is provided by Fidante Partners Limited ABN 94 002 835 592, AFSL 234668 (Fidante Partners), the responsible entity and issuer of interests in the Ardea Real Outcome Fund and ActiveX Ardea Real Outcome Bond Fund (Managed Fund) (together, the Funds). Ardea Investment Management ABN 50 132 902 722 AFSL 329 8289 (“Ardea”) is the investment manager of the Funds. The information has been prepared on the basis that the reader is a ‘wholesale client’ within the meaning of the Corporations Act 2001. It is intended to be general information only and not financial product advice and has been prepared without taking into account your objectives, financial situation or needs. You should consider the product disclosure statement (PDS) and any additional information booklet (AIB) for the Funds before deciding whether to acquire or continue to hold an interest in the Funds. The PDS can be obtained from your financial adviser, our Investor Services team on 13 51 53, or on our website http://www.fidante.com.au. Please also refer to the Financial Services Guide on the Fidante Partners website. Past performance is not a reliable indicator of future performance. Neither your investment nor any particular rate of return is guaranteed.
It is not intended to be relied upon as a forecast or research and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy, nor is it investment advice. Fidante Partners makes no representation or warranty as to the accuracy of the data, forward‐looking statements or other information in this material and shall have no liability for any decisions or actions based on this material. Fidante does not undertake, and is under no obligation, to update or keep current the information or opinions contained in this material. The information and opinions contained in this material are derived from proprietary and non-proprietary sources considered by Fidante Partners to be reliable but may not necessarily be all-inclusive and are not guaranteed to be accurate.