Harbour Asset Management has rejigged its Income Fund with a new mandate encompassing a broader range of underlying assets and more scope for active management strategies.
Mark Brown, Harbour head of fixed income portfolio management, said the revised approach would enable the fund to invest directly in assets including high-yield debt and loans.
Under the current set-up the Income Fund invests into two underlying Harbour products – the NZ Corporate Bond and the Australasian Equity Income funds, split two-thirds and one-third, respectively.
“While that was a simple way to create an income solution, the two underlying funds operate independently and with different objectives,” Brown said. “We decided to find out what other things the Income Fund could invest in to achieve its goal.”
He said after an extensive review process Harbour freed up the income fund to invest on its own account into the usual range of investment grade fixed income instruments as well as high-yield bonds and the Australasian loan market.
“There’s also some scope to invest in the Harbour Focused Equity fund as well as global equities [via T Rowe Price] and international bonds – although we haven’t appointed a global fixed income manager yet,” Brown said.
The loan market, he said, represents a relatively new – and potentially lucrative – opportunity for NZ fund managers that has been created as regulatory pressure squeezes bank funding from the sector.
For example, prior to recent changes introduced by the Australian Prudential Regulation Authority (APRA) – which polices Australia’s banking sector among other duties – banks could provide relatively cheap funding to third-party lenders building up books of asset- or mortgage-backed loans.
“Now under APRA rules banks face capital charges for financing those loans, which means costs have gone up for that source of funding for lenders,” Brown said. “But fund managers don’t have those capital costs. We can be more efficient providers of loan funding – and get paid a good price for doing it.”
He said Harbour had evaluated just a handful of so-called ‘warehouse funding’ investment opportunities in NZ to date – including car loans, industrial equipment lending, and Farmers Card – but others were hitting the market soon.
While introducing loans into the mix brings new risk factors (and echoes of pre-GFC activity), Brown said Harbour would have full look-through into the underlying assets. Regardless, the exposure to loans ranks below equities on the risk spectrum.
“Prior to the GFC, I chose not to invest in CDOs [collateralised debt obligations] because I couldn’t see through the products,” he said. “But with the loans we are considering we can understand the business and markets they operate in and get complete transparency of the risks.”
Collectively, loans and high-yield debt could make up as much as 30 per cent of the revised Income Fund investment mandate, Brown said, “but we can also take it to zero”.
“We can take every asset class to zero in the fund,” he said. “That allows us to capture yield while adding active risk management strategies.”
In a letter to Income Fund retail investors, Harbour says the changes – due to take effect on June 19 – would “help lift the running yield and expected return of the Fund, while providing diversification benefits”.
“As a result of these amendments, we are changing the return objective of the Fund from the Official Cash Rate (OCR) plus 2% to the OCR plus 3.5%. Our modelling suggests that, with these changes, the return volatility of the Fund will remain below that of a typical Balanced Fund,” the letter says.
“We are also pleased to confirm that the management fee for this Fund will, effective 19th June 2017, reduce from 77 basis points to 63 basis points.”
Brown said while the changes officially apply only to the retail fund – which has about $2 million under management – the enhanced mandate was also designed to appeal to existing and new wholesale investors (currently representing close to $90 million).
At transition he said about 80 per cent of the underlying Income Fund assets would remain unchanged.