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Templeton Reins in Aussie Credit Risk by Favoring Shorter Bonds

  • Canobi says he’s avoiding going too far down the credit curve
  • Favors ‘defensive’ sectors such as utilities, consumer staples

Franklin Templeton is hunkering down in Australia, favoring higher-quality corporate bonds with shorter tenors as global risks mount.

Templeton, which oversees about A$3.8 billion ($2.8 billion) of assets for Australian clients, has in last two months reduced the credit duration of its portfolio to almost 2 years from about 2 1/2 at the start of 2016, according to Andrew Canobi, director of fixed-income in Melbourne. Credit duration measures how much a bond price is likely to change as its yield premium over the benchmark rate shifts. The money manager favors “defensive” companies such as utilities and sellers of consumer staples, while securities maturing in two-to-five years are his main area of focus.

Volatility has spiked as the risk grows that the U.K. will choose in a vote next week to leave the European Union, while the Federal Reserve’s ability to raise U.S. interest rates could be stymied by signs of economic weakness. The U.S. central bank on Wednesday opted not to shift its benchmark and Chair Janet Yellen said that some of the forces holding down rates may be long-lasting. Speaking ahead of the Fed decision, Canobi also underscored political risks from upcoming elections in Australia and the U.S.

Maintaining Firepower

“We don’t think now is the time to go stretching too far out on the maturity curve,” Canobi said. “We don’t think it is the right time to go too heavily down the credit curve in terms of quality as well.”

About 80 percent of Templeton’s Australian fixed-income exposure is Aussie dollar based, with the balance hedged to the currency, he said.

The fund manager is also reducing exposure as it expects the recent credit rally to lose steam in the coming months and is happy to maintain “firepower” within its portfolio, Canobi said.

“We are avoiding really going far down the credit curve in an environment where yields are low and where, in the temptation to chase yields, one gives up liquidity,” he said.

Canobi also questioned the prudence of loading up on credit with companies in Australia struggling to boost revenue and acquisition activity increasing. While credit has been supported by global investors searching for yield, the risks are “to the downside,” he said.

Shunning Sovereign Bonds

That said, he’s still not embracing the very safest assets and at present doesn’t hold anything issued by Australia’s federal or state governments, even as the prospect of further Reserve Bank of Australia rate reductions weighs on yields. Australia’s benchmark 10-year rate on Thursday dropped below 2 percent for the first time on record and was at 1.999 percent as of 12:28 p.m. in Sydney. The central bank’s cash rate currently stands at a record low 1.75 percent following a 25 basis point easing in May.

Canobi expects two more quarter-point rate cuts from the RBA before the end of the year and that the consumer-price index reading on July 27 will be the next trigger for a move. Swaps traders were pricing about a 70 percent chance of a reduction by the end of this year, data compiled by Bloomberg showed.

“We are being targeted in where we are taking risk,” Canobi said. “The overarching theme for us is being pretty conservative.”

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