State Super Financial Services (SSFS) is cautious about the bondification of equites as it can give an unintended bias to interest rate sensitivity.

The term has been highlighted in CREATE – Research and Principal Global Investors’ annual global survey of 705 pension plans, sovereign wealth funds, asset managers, pension consultants and fund buyers, which predicts bondification will continue to gain traction amongst investors.

Damian Graham, chief investment officer at SSFS, is an advocate of a low volatility approach to investing, but thinks low volatility equities are not a good replacement for bonds, particularly as the fund has a base case for bond yields increasing.

“We don’t invest in equities because they are more bond like, we invest in them because they will give us lower volatility of returns,” Graham said. “Some of the bondification strategies tend to tilt you toward companies that are more interest rate sensitive, such as telecommunication or utilities, and that is something of which you need to be aware.”

Bondification is the term used to describe a low-volatility strategy in equities, for the objective of generating a smoother ride while producing a better return than received from a bond’s coupon. This is achieved by investing in stocks with good dividends, less debt, strong pricing power, free cash flow and a high return on equity (ROE).

According to research conducted by CREATE – Research and Principal Global Investors (PGI), in the period 1989-2014 the dividend pay-out of quality companies made a big difference to overall returns, as exemplified by the S&P 500 Total Return Index (including dividends).

Dividends as a percentage of profits have been rising steadily for FTSE 100 companies and currently stand at 65 per cent, giving a yield of 3.4 per cent.

The report says other funds in the superannuation sector are continuing a bondification rotation, i.e. reallocating from bonds to equities. However, this is tempered by investors’ awareness of volatility. Drawdowns of 30 per cent or more have occurred, on average, once a decade since 1870.

The report added that the usual “greed-fear cycles can cause price swings 13 times greater than is justified by fundamentals alone”, though for most investors the perceived price of staying out of the equities market is even greater – this is particularly true as there are signs this is a once in a generation bull market.

 

The Conexus Financial inaugural Equities Summit is taking place at the Crown Tower, Whiteman Street, Southbank, Melbourne on September 8 and will bring together chief investment officers, heads of equities and portfolio managers from Australia’s largest asset owners to discuss the latest global outlook for equities, the latest thinking in portfolio management, and best practice solutions for equities portfolios.

To see the agenda and to register click here.