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Best Bond Fund Sees No Normal in Broken Market: Australia Credit

Credit markets are in uncharted territory as the global recovery is threatened by a mismatch between companies hoarding cash and record government debt, said Australia’s top-ranked bond manager.

“It’s pretty clear that the credit cycle is still broken,” Jeff Brunton, head of credit at AMP Capital Investors, said in an interview in Sydney this week. “I’ve been doing this for 20-odd years and it just feels very, very different to a normal cycle.”

Global growth may be a below-average 2.4 percent this year, forecasts compiled by Bloomberg show, even as central banks pour unprecedented sums of cash into the financial system. While AMP expects the rally that’s taken corporate borrowing costs to a five-year low to hold, it’s also buying derivatives to protect against risk aversion as policy makers grapple with a European backlash against austerity, Brunton said.

The AMP Capital Corporate Bond fund has delivered the best return among Australian fixed-income peers over the decade to Jan. 31, offering an average annual gain of 7.2 percent, according to Morningstar Inc. rankings. Over the same period, investors in Aussie corporate notes earned an annualized 7 percent, a better performance than any other developed market tracked by Bank of America Merrill Lynch indexes.

While more corporate borrowers are increasing profits, governments in the developed world remain mired in debt. Officials from Madrid to Washington and London are faced with the dilemma of trying to improve stagnant economies while combating deteriorating finances with austerity measures.

‘Rocky Path’

“It will be a very rocky path to find our way out of this,” said Lyn Cobley, Treasurer at Commonwealth Bank of Australia, in an interview in Sydney yesterday. “We’re in absolutely uncharted waters when you look at the level of government debt there is around the world, the level of central bank easing and liquidity that’s been pumped into the markets. How we retrace and retract from that is inevitably going to be volatile.”

Last month’s Italian election, in which the euro-region’s most-indebted nation was left with a hung parliament, was “a pretty important vote against austerity in a major peripheral country in Europe,” said AMP’s Brunton, adding that spreads didn’t widen as he expected in response.

Yield Premiums

Australian corporate bonds yielded 142 basis points more than government bonds on March 12, holding at the lowest level since December 2007, according to Bank of America data. The premium averaged 215 basis points over the past year, compared with 179 for a comparable U.S. index.

Signs of economic improvement in the U.S. and global central bank commitments to relaxed monetary policy are keeping spreads contained, Brunton said, although he expects further “significant risk-off events” to occur. As well as the disruption in Italy, there is also the prospect Spain will lose its investment-grade credit rating and be forced to seek assistance from the European Central Bank, he said.

“We’re really holding the powder dry until we see those events,” Brunton said. AMP is “an active user of derivatives” and trades credit-default swap indexes to control market risk, he said.

Default Swaps

The Markit CDX North American Investment Grade Index, a benchmark investors use to hedge against losses or to speculate on creditworthiness, closed on March 11 at 79.5 basis points, the least since February 2011, according to data provider CMA. It climbed to 79.7 yesterday.

Brunton, 43, has been head of credit at AMP since January 2008. His team there manages more than A$10 billion ($10.3 billion) out of the company’s A$128 billion in assets. Brunton previously worked at Queensland Investment Corp. in Brisbane as head of global credit and as head of Australian fixed interest and cash.

AMP Capital’s corporate bond fund also delivered the best return over a three-year time horizon and the second-highest in the year to January, according to Morningstar. It handed investors an 11 percent return over the 12 months, behind only the 11.3 percent gain on the Macquarie Core Plus Australian Fixed Interest Fund, the data show.

AMP beat its competitors in recent years by buying debt sold by U.K., French and Swiss banks, and piling into 5- to 10-year notes sold by Australian property companies and utilities, Brunton said.

Expensive Sovereign

The nation’s sovereign bonds are expensive, even though their relatively higher yields are attractive to offshore investors, he said.

The benchmark Australian 10-year yield fell three basis points to 3.59 percent as of 1:30 p.m. in Sydney, offering 191 basis points more than the average for the nine other sovereign markets graded AAA at all three major ratings companies. The Australian rate yesterday touched 3.64 percent, the highest level since May 2.

According to Brunton, most corporate borrowers are in the “recovery” stage of the credit cycle, in which debt is falling and profits are positive. In contrast, sovereigns in Europe and the U.S. are beset by rising debt and deficits.

“The credit cycle’s broken because we’ve got so much desynchronization in the cycle that we can’t actually get the credit creation mechanism to function as it should,” Brunton said. “We’ve got too much debt at the sovereign level. We talk about kicking this down the road, but the reality is it’s got to be dealt with.”

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