Why a fixed income fund’s benchmark matters

We would argue that the choice of benchmark deserves more consideration from investors

Investors typically do not give the benchmarks of their funds much attention. However, we would argue that the choice of benchmark deserves more consideration from investors, especially in the case of multi-asset income funds that have access to a broader investment toolkit.

Why do we argue that the choice of benchmark is important?
Fixed income funds are typically benchmarked to a bond or cash-related index like the ALBI or STeFI. The PSG Diversified Income Fund however, is unique in its category, in that it has a benchmark of inflation plus 1% over rolling 2-year periods. We believe the objective of outperforming inflation is an important (and relevant) differentiator for fixed income investors, since inflation erodes the value of the income received over time. We believe the need to outperform inflation will become critical in the years ahead, especially given a more volatile inflationary environment.

While we are currently engaged in a rate hiking cycle, real interest rates on cash (i.e. interest rates net of inflation) are currently negative, making it especially challenging for investors to maintain the purchasing power of their money if they rely solely on cash investments to do so. Thus, we believe that it is important that investors expand their fixed income toolkit beyond cash and cash-like instruments.

The PSG Diversified Income Fund is unique in its category
To deliver on its objective of outperforming inflation plus 1% over rolling 2-year periods, the PSG Diversified Income Fund invests in a mix of local and foreign assets to provide a core fixed income portfolio comprised of the full breadth of fixed income securities. The fund also utilises exposures to listed property, preference and ordinary shares when attractive, adding differentiated return and risk drivers to the core fixed income portfolio. These investments average below 10% of the fund in aggregate through cycles, yet provide the ability to opportunistically strengthen returns through small but valuable allocations to a wider range of mispriced assets than typically seen in this category of funds, while still keeping the objective of capital preservation in mind.

But what about risk?
The fund is managed with the needs of an inflation cognisant, yet conservative, fixed income investor in mind. We aim to achieve the best outcomes for our investors while keeping risk within tightly defined parameters by dynamically managing risk, allocating capital to the best areas at different points in the cycle. We apply a disciplined approach and only invest in securities that meet our real return requirements (return above expected inflation). While investors should be comfortable with a small degree of exposure to market and interest rate fluctuations, investors in this fund have only seen two negative rolling 3-month returns over the past 10 years, both during the outbreak of Covid-19 in 2020, evidencing the reliability of returns.

While we aim to achieve our benchmark of CPI+1, our dynamic approach of buying only when we believe assets are mispriced has rewarded clients as the fund has returned closer to CPI + 2.9% p.a. over rolling 2-year periods at appropriate levels of risk. Over long periods, these returns are similar to that of the typical ALBI-benchmarked bond fund, at significantly less duration risk and lower volatility.

Rolling 2-year performance (annualised)

In short, we believe that having aligned the benchmark of this fund to a key investor challenge, allows us to achieve better outcomes for investors over the longer term. Risks within the portfolio are carefully managed with capital preservation top of mind. The fund can be viewed as a core fixed income portfolio which delivers attractive inflation beating income returns at appropriate risk levels, while also solving allocation decisions on behalf of our investors to position them appropriately in different cycles. This removes the risk of emotional investor responses that may impact on the ability of investors to achieve their longer run investment objectives.

For full details on the PSG Diversified Income Fund view the MDD.