PIMCO's Case For Fixed Interest

Happy are those who are fully invested, for theirs will be capital gains. Less happy are those who will be looking to invest over the next few years, as they find prices have been pushed up.

Of course that’s still a lot better than not having anything to invest in the first place, but the problem of massive and growing funds looking for opportunities was one of the key messages from the Australian Super Investment Conference in Cairns this week.

The total investment market is like any other '” greater demand forces up prices, so reducing yields. The danger, as outlined in the accompanying video interview, is that investors will be lured to increase their risk exposure as they try to find the high yields they had come to expect.

Lowering expectations, telling investors they should be happy with single-digit returns, is about as hard as telling the average member of Generation Y that it is entirely reasonable that they can’t have it all now. Yet lower expectations is a recurring theme among professionals after two great years.

PIMCO is an international leader in what is generally an unfashionable area for private investors: bonds. PIMCO does nothing but manage fixed interest, but it does it so well that it has nearly $US500 billion under management. It’s to be expected then that PIMCO’s Asia-Pacific portfolio management head, Kumar Palghat, would want to talk up the bond market’s performance, but his warnings about the current fashionability of hedge funds and alternative investments is nonetheless worth considering.

A problem facing many of the industry super funds attending the conference (and individual investors) is how to satisfy members after the past year’s great returns. Although the Australian stockmarket’s outlook remains reasonably optimistic, the pressure is on to unearth the quality diversifications that will add extra performance to the portfolios.

The industry fund sector was relatively early into infrastructure investments, but now the fee gougers of Macquarie, Babcock & Brown and a host of imitators are scouring the world for projects, forcing prices and fees up and yields down in the process.

Now it’s not a problem for funds managers deciding whether or not to invest in infrastructure or private equity vehicles, but whether they can get any allocation.

That’s forcing funds to look to newer managers without the track records or connections of the established players. “Lack of deal flow” is the complaint.

Kumar Palghat is concerned that “alternative investment classes”, now so feverishly exercising investors’ minds, will bubble like every other fashion. Adding another couple of hundred basis points’ performance is not risk-free.

The search for “alpha” '” active management’s skill in adding value '” comes at another price: higher fees. And it’s not just high performance fees either.

Frontier Investment Consulting’s managing director, Fiona Trafford-Walker, warned that managers’ fees are on the rise because of greater complexity and costs of regulation and compliance. With the tsunami of compulsory superannuation pushing up demand, managers with the alpha magic are in demand.

The rise of industry funds played a big role in starting to rein in fees '” “keeping the bastards honest” '” so it is particularly worrying to sit among such players and hear fees are going up, particularly if returns are returning to trend. Unlisted vehicles, infrastructure plays, good private equity funds and venture capital do not come cheap anymore.

The realisation that capital markets of unprecedented liquidity are searching the globe for opportunities makes this a most interesting time, with the issues concerning trustees looking after billions of dollars confronting the small investor sector as well.

For example, one of the international guest speakers was Charles Jacklin, president of Mellon Capital Management, preaching the opportunities of adding performance through the foreign exchange markets. Mellon Capital Management has had a successful run in adding value with its forex fund. Meanwhile, at the other end of the market, it’s hard to open a paper without finding some sort of advertisement trying to convince the public that playing the forex market is easy, money for jam, just come to a free seminar '¦ you know the story.