- Fixed Income big time underperformance

Fixed Income big time underperformance

Written by Wilfred Ling

Tuesday, 27 January 2009

I did a brief survey of the fixed income funds available at fundsupermart. Over the past 1 year, only 6 funds out of 48 fixed income funds that have more than 1 year track record achieved positive return and the best return was merely 6.74%. The rest were negative returns and the worst was -39.32%. This is despite the sharp falling interest rate. Currently, US interest rate is almost at zero percent. We should see a corresponding sharp increase in bond price. Bond price is inversely proportion to interest rate. To provide a simple illustration, let's say a bond has a coupon of C and its current price is P1 having an interest of say 3%. If the interest rate of a similar bond is cut to say 2%, it means that the bond must drop using the following equation:

C/P1 = 0.03
C/P2 = 0.02

=> P2 = P1 x 0.03/0.02
=> P2 = P1 x 1.5

This imply that the bond price should appreciate by 50%! Of course in reality it is more complicated than this but the illustration demonstrates why falling interest rate is good for existing bond prices.

What we are seeing with fixed income unit trust is that this is not happening. The reasons are:

Many of these unit trusts are investing in corporate bonds and emerging market bonds. These bonds have been affected by the market environment. Investors do not think that companies could repay their debt and similarly lacks confident that emerging market countries could repay their debt too;
Unit trusts generally underpeforms the market. These fixed income funds are merely exhibiting what is already known that active fund managers are generally incompetent.

The corresponding total return of the various sovereign bond market are as follows:

From 23 Jan 2008 to 23 Jan 2009 (returns are all its SGD with dividends included):

*Barclays Capital 10-20 Year U.S. Treasury Index +13.16%
**Barclays Capital Global Treasury ex-US Capped Index +1.03%
+JPMorgan EMBI Global Core Index -10.41%

* Using Barclays 10-20 Year Treasury Bond Fund (TLH) as the proxy
**SPDR Barclays Capital International Treasury Bond (BWX) as the proxy
+Using JPMorgan USD Emerging Markets Bond Fund (EMB) as the proxy

A few points to note: A market capitalization bond fund would have a large portion in US treasuries. Therefore, such a fund should have a nice single digit return considering international sovereign bonds (such as Japan, Europe and UK) are in their single digit return.

For emerging market bond returns, the 1 year return was -10.41%. I don't see how would any fixed income fund can lose 39% in its NAV!

Here are some lessons:

Active managed funds do not outperform its index return. This include the so called “less” efficient market such as the emerging market return.
When investing in fixed income, it is always prudent to stick with high quality sovereign bonds. Stay away from higher risk instrument such as corporate bonds and emerging market (including so called “investment grade” asia bonds.) You can gain the potentially higher return from corporate investing via equity.
Get index funds instead. However,the availability of index fund in Singapore is just pathetic. Sometime I wonder whether is there a conspiracy behind the lack of index funds. So it looks to me that the only way is to go ETFs.

How to get ETFs? ETFs are available from brokerage firms. However, I have received numerous complains that various so called brokerage firms do not have the relevant ETFs on their platform. As a financial adviser, I had approached one brokerage firm whether could they include the ETFs I have in mind for my clients. Their response? They asked me how much business I can bring them before they consider my request. I found this pure pathetic and complete lack of customer service. It seems to me that it is all about $$$. In fact, the entire industry is purely driven by $$$. Financial advisers do not recommend ETFs because it pays no commission and the brokerage firms do not carry the good ETFs because of the lack of volume in Singapore. In the meantime, the pathetically few index unit trusts is at its dangerously low fund size. Infinity Global Stock index is at S$9.1 million, Infinity Europe Stock index at S$9.5 million, Infinity US 500 Stock index at S$11.2 million.

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