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Gross performance returns and benchmark performance shown do not include expenses, fees or tax. Net performance returns are prepared on an exit-to-exit fee basis which includes all ongoing fees and expenses.

Market Review

• In the second quarter of 2010, the European sovereign debt crisis reached a breaking point and extended to broader credit markets, while negative surprises started surfacing in the US and global economic data in June, notably from China.
• Risk aversion and deflationary fears combined with a large short covering rally to take global intermediate interest rates 50 to 85 basis points lower, led by the 10-year USD treasury down 85 basis points to 2.93%.
• Global credit indices underperformed treasuries by around 2.5%, giving back more than their first quarter excess returns, but still delivered positive absolute returns, especially in the USD market.
• The US economic data initially supported the thesis of a robust recovery, with most of the data coming on the strong side of expectations in April and May. However, the strength of the data started waning with the poor private sector payroll number for May (+33k) and a slew of disappointing housing market data such as a 33% drop in new home sales, which were followed by a sharp drop in consumer sentiment for June (to 52.9 from 63.3) and in ISM manufacturing (to 56.2 from 59.7).
• Core CPI was stable in May at 0.9% y/y but 10-year breakeven inflation rates fell over 40 basis points as deflation fears were re-ignited by the weaker economic data. Swap spreads widened significantly over the quarter on lower treasury issuance forecasts and funding concerns centered on Europe, but settled down in June.
• In Europe, the long shadow of the sovereign credit crisis has taken the average spread of European peripheral markets up by 200 basis points over German government bonds over the quarter.
• The ‘all-in’ E750bn government bail-out package announced by the European Union (EU) and the International Monetary Fund (IMF) on May 10th failed to reverse the rise in credit risk premia in European debt markets, especially for Greece and Spain, whose 5-year Credit Default Swaps (CDSs) are 350 and 80 basis points higher on the quarter respectively, but also for core European sovereigns like France whose CDS shot up nearly 30 basis points towards 90 basis points in June.
• The European Central Bank’s (ECB) purchase of European government bonds has provided an important backstop for holders of Southern European bonds, but has not restored order and liquidity in Euro zone government bondmarkets.

• As the European corporate debt market was temporary shut, concerns have escalated about the health and funding position of European banks despite the revival of 3-month full allotment auctions by the ECB and large excess deposits at the ECB.
• The net impact has been a massive flight to quality into German government bonds, pushing the 5-year Bund rates 67 basis points lower to 1.49%. Recent Euro zone economic data has been consistent with the continuation of a modest, positive rate of economic growth.
• The June euro zone PMI Manufacturing was stable at 55.6, and unemployment has stabilized. However, retail sales remain weak and the uncoordinated fiscal tightening plans announced by various European capitals may thwart the economic recovery.
• In the UK, the coalition government elected in early May rapidly set to work and announced radical budget consolidation measures, based on independent economic forecast produced by the newly established Office of Budget Responsibility.
• This emergency budget was welcome by the market and provided strong support to the Gilt market. Intermediate Gilts were further helped by dovish comments from Monetary Policy Committee (MPC) members and managed to keep pace with Bund yields over the quarter.
• In Japan, Prime Minister Hatoyama resigned and his successor ex-Finance Minister Naoto Kan has been known to push for fiscal reform and for more aggressive positive inflation targets. The economic data still points to a strong recovery in exports and continued improvement in business sentiment, but monetary policy is expected to remain biased towards further easing.
• Many other markets were marked by changes in policy stances: the Bank of Canada became the first G7 central bank to raise its policy rate in this cycle. The 25 basis points hike to 0.5% was well telegraphed but was accompanied with caution about the external economic environment and the market is only pricing in one more hike until year-end.
• The Riksbank also raised its repo rate by 25bp to 0.5%, as expected, but downgraded slightly its growth and inflation forecast slightly in the outer years.
• In Australia, while the Reserve Bank of Australia (RBA) raised its cash rate twice to 4.50%, Australian dollar bonds were amongst the best performers over the quarter and the yield curve implies that the RBA could be on hold for two years.

Portfolio Review

The Fund retuned 3.31% (before fees) over the June quarter, versus the Barclays Capital Global Aggregate Index (AUD Hedged) return of 3.34%.

Some of the key contributors and detractors to the Fund performance over the month were as follows:

Positive contributors:

• The portfolio’s overweight duration positions in Australia and Canada significantly contributed to performance as rates rallied over the quarter.
• Our positions in Japan Government Inflation Linked Bonds (JGBis) contributed to performance on the back of strong results in the second half of the Ministry of Finance buy-back program.

Negative contributors:

• Our overall duration positioning in the Asia bloc had a negative impact as our underweight duration position in Japan detracted fromperformance, while our underweight in non-Japan Asia had a neutral affect.
• The portfolio’s sector positioning in the Dollar Bloc detracted fromperformance overall. Our long position in Capital Securities significantly weighed on performance. The negative tone in credit that began in May due to debt problems in the European peripheral countries continued into June as fears of a slowdown of growth, especially in the US and China, weighed on themarket.

Fund Outlook

• One month ago, we noted the persistence of a gap between poor market sentiment and good economic data. The recent moderation in underlying economic data suggests that the economic recovery has entered into a new phase and that markets have been rightly discounting a more challenging environment for global growth.
• In the US, the end of quantitative easing at the end of March and the end of the home buyer tax credit were adverse, material events for liquidity and consumer demand.
• In Europe, the banking sector’s exposure to sovereign credit risk is limiting their funding options and many banks are heavily dependent on the liquidity drip-feed from the ECB, so risks to credit and growth are elevated.
• Finally recent ISM, vehicles sales and energy consumption data from China point to a marked slowdown in economic activity from the single brightest sources of global demand.
• Events in Europe illustrate how financial crises-led recessions often lead to sovereign debt crises. In developed markets, governments are reacting to the heightened risks presented by the dire state of their public finances, by reigning in fiscal expenditures.
• Central banks, in contrast, have been given the tools to guard against credit accidents while excess leverage is worked out. In contrast, in developing countries and commodity-led economies, central banks are on the move to tighten or at least normalize monetary conditions.
• Financial markets have been assigning an increasingly high probability that policy makers will get the balance wrong, i.e. stifle growth in developed markets, and let inflation slip in commodity-led markets.
• The latter risk is now largely priced out (e.g. there is no more RBA hike priced in the AUD yield curve), but the former risk has not. Short-end EUR/USD/GBP bond yields in particular are through their historical lows, but yield curves have remained quite steep.
• This suggests that the market is exceedingly concerned about a double-dip, and yet it expects the pull of monetary expansion to succeed in averting deflation. Thus we are biased to be underweight duration overall, and we maintain a significant yield curve flattening stance.
• In risk assets, we have been keeping our powder dry, but we see opportunities to buy cheap securities without making any concession on credit quality.
• We think that the re-emergence of corporate bond supply is a positive for the near term direction of spreads especially the demand for financial new issues.
• Credit spreads have lagged the declines in equity volatility, and the EFSF and upcoming bank ‘stress test’ show that market concerns are slowly being addressed.

About the Fund

Investment objective

• The Fund aims to outperform the benchmark Lehman Global Aggregate 500 Index (AUD hedged) Index by 150 basis points p.a. (before fees) over rolling 3 year periods.
• The Fund seeks to achieve its performance objective through the taking of active risk versus its benchmark index in strategies based on areas including, but not limited to, the following:
  – duration;
  – yield curve selection;
  – sector (eg. credit) selection;
  – issuer; and
  – country, security and currency selection.
• The Fund benchmark is hedged back to Australian dollars. We may, however, take active currency positions relative to its fully hedged benchmark subject to certain restrictions.

Fund strategy

The Fund is actively managed within a rigorous risk management framework. The portfolio is continually monitored and, where necessary, adjusted to suit changing economic and market conditions. Great importance is placed on research and a team based approach to making investment decisions.

The investment process is focused on accessing the best ideas of our global fixed income team. The Team seeks to add value by managing duration, yield curve, and sector (eg. corporate, mortgage backed, agency debt, etc) and individual security, country and currency exposures against the benchmark.

In seeking to access a broad array of enhancement strategies, we utilise proprietal research-based knowledge, fundamental macroeconomic and credit, sector and security analysis. The management of risk is central to our
investment process. The Team reviews the Fund exposures on an ongoing basis to ensure the Fund maintains a risk/reward profile appropriate to changing market conditions and the degree of confidence we have in our return expectations. 

Designed for investors who…

• Seek a fund which aims to provide capital growth and some tax effective income.
• Accept the risk of significant price fluctuations.