JCB ACTIVE FUND IS A PORTFOLIO OF LONG ONLY AAA AND AA+ RATED EXPLICITLY GUARANTEED GOVERNMENT BONDS. SINCE INCEPTION ANNUALIZED RETURNS ARE CURRENTLY 5.43% NET OF ALL FEE’S.

• ASSETS MARKETS GET HIT AHEAD OF US ELECTION
• INFLATION REMAINS PROBLEMATIC FOR RBA, BUT SA FLOODS PRODUCE TEMPORARY HEADLINE CPI POP
• EXCEPTIONAL SUPPLY DRAGS ON BONDS PRICES IN OCTOBER

Investment markets decayed in October, pricing in additional risk premium ahead of the US presidential election. Both equities and bonds suffered declines over the month, as investors repositioned to face the prospect of a Trump presidency. Investment markets grew increasingly confident that the FOMC would complete on a single rate hike by year end in their December meeting, assuming the market could navigate the US election and Italian Senate referendum without major hiccup. Volatility continued to increase across most markets, led by GBP Sterling currency which suffered a ‘flash crash’ of over 6.00% early in the month.

Australian inflation remains problematic for the RBA, with Q3 data showing year over year CPI weighted mean decaying to only 1.3%. Headline inflation came in stronger at 0.7% quarter on quarter, but this was significantly affected by South Australian floods causing a 20% rise in fruit and vegetable prices. Once supply normalises in these fruit and vegetable producing regions, this headline shock will be removed, causing a future drag on the already weak domestic inflation picture. This continued decay in domestic inflation, combined with AUD currency which refuses to fall, maintains a slight easing bias at the RBA into 2017. Notwithstanding the prospect of a rate hike from the Federal Reserve in December; the fact that it has taken the combination of still incredibly easy monetary policy in the developed world and a surge in credit growth in China to produce around average global growth suggests that the prospect of much materially higher global interest rates over the next few years remains highly remote. And given the sensitivity of the Australian dollar to differences between Australian and global interest rates, that would also suggest that an historically low RBA cash rates are likely to remain a feature of the Australian economy for some time.

Over the course of October, bond markets initially decayed, following international markets higher in yield. In the middle of the month, two specific transactions contributed substantial supply to the market over an 8-day period, in the issuance of Australia’s first ever 30-year Government Bond and an interest rate swap transaction for the sale of AusGrid electricity network in NSW. This supply was truly exceptional in both size and market risk. Initially the Government had telegraphed a desire to issue 4 billion 30yrs bonds. Upon opening the transaction, the initial order book was north of 14 billion in a matter of hours, and as such the government upsized the transaction to 7.6 bln. This alone was the largest ever duration issue in Australian Fixed Income history. Hot on the heels of this transaction was the AusGrid interest rate swap which produced around 10 bln of varying but longer dated maturities of duration supply to the market. This is exceptional because the combined duration of both transactions issued in a 8 day period eclipsed the entire duration of the Australian Government Bond market of 2007. Put another way, how much market concession would be required to re IPO the ASX equity market of 2007 in an 8-day period? This heavy issuance was a major contributor to the pullback seen in bonds prices over the month.

FUND UPDATE FOR OCTOBER

The JCB active fund declined by -1.48% (gross) in October, beating the index by 0.35%. The fund remained cautiously positioned vs the market heading into the month, retaining an underweight duration exposure and curve steepening structures in anticipation of long end supply concessions. After a significant duration concession in the issuance of the new Australian 30 year bond, we lifted the portfolio’s exposure back toward benchmark, capturing outperformance in the process. The Ausgrid transaction was unexpected by the market and hence we didn’t manage to generate any additional alpha return around this market movement, but did suffer beta decay. We continue to like building the portfolio with a heavy skew to short dated bonds that now carry at positive yields vs the RBA cash rate as we believe these offer compelling risk/reward over time.