Financial Review – Cecile Lefort
From music to fixed income, Daintree Capital’s Justin Tyler says the key to investing in fixed income is “avoiding the losers”. The fund manager has snapped up hybrids in the aftermath of Credit Suisse’s collapse and expects another rate rise from RBA.
Bond manager Justin Tyler says that while a new era of fatter pay packets is a good development for the broader economy after years of inertia, it will also make it harder for the Reserve Bank of Australia to suppress cost pressures.
The founding partner of $1.5 billion fixed income manager Daintree Capital says higher salaries will keep the central bank on guard and could lead to another rate increase this cycle. The central bank has already lifted the cash rate by a whopping 3.75 percentage points in just one year.
“I felt that if I was to do music as a career, I might lose my love of it,” says Justin Tyler. Dominic Lorrimer
Even so, he says the time has come for the trend of repressed wages to reverse. The share of total income paid to workers – also called the labour share – has been falling in Australia since the 1970s when capital owners saw their profits climb.
It is “a good thing when parts of the labour market are experiencing some increased pricing power. It has been a long time coming” says Tyler, who is responsible for interest rates and currency decisions at the boutique fund manager.
“Ultimately, if compensation to labour is not sufficient for long enough, then the aggregate level of demand in the economy is likely to fall and that’s actually bad for businesses.”
Data released last week showed that salaries hit a decade-high of 3.7 per cent in the March quarter, driven by strong growth in private sector pay packets. But policymakers are worried about the risk of a damaging price-wage spiral, with wage growth still far below headline inflation at 7 per cent.
The RBA expects wages growth to peak at 4 per cent by the end of the year, before slowing to 3.8 per cent in 2024 as the economy cools on the back of higher borrowing costs. There is still uncertainty ahead of the Fair Work Commission’s decision on the national minimum wage, amid suggestions it could be a 6 per cent increase.
“The RBA has been very clear that inflation is the number one priority and if it doesn’t pull back to target by 2025, you’ll see higher rates and perhaps a weaker labour market and that may bring about a slowdown,” Tyler warned.
On a knife edge
The RBA this month raised the cash rate to a decade-high of 3.85 per cent instead of extending a monetary pause that was widely anticipated by the market. The central bank also flagged that more tightening may be required amid accelerating inflation in the labour-intensive services sector.
Bond futures imply a 64 per cent chance of a final rate increase from the central bank by August and anticipate rate cuts next year.
Tyler says the Australian economy is on a knife edge, with a bigger chance of a mild slowdown rather than a severe recession. He also believes sticky inflation may keep interest rates higher and for longer than people may expect.
And structural changes in the economy, he cautions, will only aggravate price pressures as the country shifts to green energy and brings manufacturing activity back onshore.
The RBA has forecast inflation to return to its 2 per cent to 3 per cent target range by mid-2025. That’s after its preferred underlying inflation measure, known as the trimmed mean or core, slowed to an annual pace of 6.6 per cent in the first quarter of the year.
Tyler, who has worked in fixed-income markets for at least 20 years, believes it could take longer for the central bank to meet its deadline.
Rising inflation has had a big effect on bond returns and has also changed the way bond managers are investing. He says that 18 months ago, investors were forced to take on a lot more risks and go deeper into the high-yield market to generate returns of up to 7 per cent. “Now you can achieve that in highly rated and very short duration investment-grade credit,” he adds.
In this environment, Tyler particularly favours senior bonds issued by Australia’s major banks with maturities of up to two years. He is negative on paper offering longer terms because the typical correlation between equity and bond – when one goes down the other goes up – has not been reliable. “I think the allocation to duration that many people have is too large and the time to lengthen is not yet right,” he warns.
Tyler also likes residential mortgage-backed securities, but he stays clear from those issued by non-conforming lenders because of the risk associated with them. Non-conforming home loans are typically for borrowers who have credit impairments or have difficulty receiving funds from a bank.
‘Boring bond guys’
Contrary to some of its fixed-income peers, Daintree’s fund strategy is “just” to meet its target return of up to 4 per cent over the cash rate, not “exceed” it. The absolute return bond firm manages three funds including a portfolio of hybrid securities.
Tyler also snapped up cheap hybrid notes after Credit Suisse’s collapse in March, when Swiss regulators stunned investors by wiping out the value of $US17 billion ($25.6 billion) of the bank’s hybrid securities after its takeover by UBS. The move scared off investors from buying the security that combines equity and bond elements.
“The whole asset class globally was punished, and we were able to pick up good value [hybrids] because of the panic,” says Tyler, singling out securities issued by Australia’s major banks.
Tyler founded Daintree with Mark Mitchell in 2017 in a 50:50 joint venture with Perennial Partners. That’s after eight years at Aberdeen Asset Management where he oversaw inflation-linked strategies before the firm’s merger with Standard Life in the UK. He also had a stint in debt capital markets at RBC and four years at Colonial First State (now First Sentiers).
A talented violinist, Tyler’s goal wasn’t always to end up in financials markets. “I was a decent enough violinist player to consider a career in music,” he reminisces.
“I felt that if I was to do music as a career, I might lose my love of it.”
These days he relaxes playing his violin with a preference for Austrian composer Gustav Mahler, whose “symphonies are good to get lost in”.
The Tyler house is big on music: his wife is in music education, his sons play the violin and cello, and the house often entertains friends from the music industry. Growing up and during university, Tyler performed as a violinist with the Sydney Philharmonia Choirs and Sydney Youth Orchestra, and sometimes as a concertmaster – or first violin. He does, however, dislike playing solo, which was an “unavoidable” part of the auditioning process.
It is no surprise then that Tyler chose to study music at the University of Sydney, although he also studied mathematics as a double major because teaching was another area of interest. It then came to a point where he had to make a choice.
That is how the young university graduate ended up at Colonial First State where he started in the research department, analysing different asset classes. He soon joined the fixed-income team, working closely with now-retired bond veteran Francois Kong.
The often-misunderstood world of bond markets has also allowed him to bring his interest in education on board.
“In fixed income, there’s an element of teaching that you can’t escape because it is not an asset class that everyone is familiar with, unlike properties and equities,” he says. “You play an educational role every day talking to potential investors, how it works, what they should expect and whatnot.”
On the newer parts of financial markets, Tyler is not a fan of cryptocurrencies. He believes its better classified as a technology that will have a range of applications in the future, rather than as an asset class – “markets have made that move way too early”.
The fund manager sees the potential for investment opportunities that will involve digital money, but not the cryptocurrencies themselves – “it will be more interesting than just investing in say bitcoin”.
As for investing in fixed income, Tyler’s strategy is simple.
“We are boring bond guys – it’s not about picking winners, it’s about avoiding losers,” he says.
Cecile Lefort is a markets reporter based in the Sydney newsroom.
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