Cash­ing in on banks The fund in­vests pre­dom­i­nantly in fixed-in­come-type as­sets and is man­dated to al­lo­cate as much as 10% to lo­cal and for­eign eq­ui­ties.

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The fund’s eq­uity ex­po­sure, which is close to its man­dated max­i­mum 10% of the un­der­ly­ing fund value, is skewed to­wards those stocks that pro­vide an­nu­ity-like in­come, ex­plains Ian Scott, man­ager of the fund. These stocks in­clude banks and life in­sur­ers.

“If you think about in­come funds, they’re ba­si­cally a quasi-bank prod­uct,” he says. This means that they need to sup­ply in­vestors with a con­stant in­come stream.

The fund sees op­por­tu­ni­ties in fi­nan­cial stocks as they’ve been “unloved” for a num­ber of years, es­pe­cially the bank­ing stocks, ex­plains Scott. Fol­low­ing the 2008 fi­nan­cial cri­sis and sub­se­quent tight­en­ing of banks’ cap­i­tal re­quire­ment rules, their risk profiles have changed for the pos­i­tive.

“Banks are much safer than they were prior to the 2008 cri­sis,” says Scott. Stricter do­mes­tic credit-grant­ing rules, through the Na­tional Credit Act, also contributed to banks’ health­ier bal­ance sheets, ac­cord­ing to him.

The fund’s al­lo­ca­tion to do­mes­tic bonds, at around 43%, is fo­cused on cor­po­rate float­ing-rate notes, which limit in­vestors’ ex­po­sure to credit risk, says Scott. Nom­i­nal gov­ern­ment bonds, which pay fixed in­ter­est rates, com­prise around 15% of the fund, he says.

There is no ex­po­sure to in­fla­tion-linked gov­ern­ment bonds, says Scott. They’re cur­rently trad­ing at yields of around 1.7 per­cent­age points higher than in­fla­tion, which makes them ex­pen­sive, ac­cord­ing to him. In ad­di­tion, these bonds are less liq­uid and don’t al­low for easy en­try or ex­its from po­si­tions, he says.

In that sense, nom­i­nal gov­ern­ment bonds of­fer bet­ter propo­si­tions with yields at about 2.5 per­cent­age points higher than in­fla­tion, ac­cord­ing to Scott.

The fund’s cash hold­ing (48% of to­tal as­sets, as at 30 April) is skewed to­wards bank debt with ma­tu­ri­ties longer than 12 months. Bank fund­ing shifted in 2014 as the stricter cap­i­tal ad­e­quacy re­quire­ments of Basel III reg­u­la­tions were adopted by lo­cal banks, forc­ing them to ad­just and align their li­a­bil­i­ties with their as­sets.

“Last year you could buy three-year bank NCDs [ne­go­tiable cer­tifi­cates of de­posit] at yields of in­fla­tion plus 2.5 per­cent­age points,” says Scott. “We took that op­por­tu­nity last year.”

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