How this income manager struck 42% upside by going global

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Global hybrids are a fresh frontier among income opportunities offering strong, risk-adjusted returns.

While Australian investors may be familiar with domestic hybrids such as CommBank PERLS, Brad Dunn of Daintree Capital says what they don’t realise is offshore peers of similar quality often provide superior yields.

“When we look at yields on offer for specific hybrid securities globally, the coupons are anywhere from 70-100 basis points higher than CBA.” – Dunn

But it’s not just better yields up for grabs. By selecting from both Australian and global banks, the Daintree Hybrid Opportunities Fund can potentially deliver better overall returns than possible through a purely domestic approach.

As an example, the fund made a 42% return on its investment in Canadian bank hybrids over the year to July 2021. The securities were trading at a discount amid COIVD volatility, but Dunn’s team bought them before they rerated due to a positive regulatory announcement that wasn’t being priced in by the market.

With additional return sources and mispricing opportunities to exploit via a global strategy, Dunn is confident of achieving returns 3.5-4.5% above the RBA cash rate after fees.

Learn more about the Daintree Hybrid Opportunities Fund and its process by watching the video or reading the transcript below.


Managed Fund
Daintree Hybrid Opportunities Fund
Alternative Assets

Edited Transcript

Hi, my name's Brad Dunn. I'm the Lead Portfolio Manager and Senior Credit Analyst of the Daintree Hybrid Opportunities Fund. I'm excited to share some of the details of the fund with you today.

The Hybrid Opportunities Fund was developed to give investors the opportunity to really access the true potential of hybrids. And we think, on top of providing regular income, which is very important for a lot of investors these days, it does two additional things that we think will really prove the worth of the hybrid asset class.

The first is it looks more globally and it takes a much more global view of the opportunities available in the hybrid space. Second of all, we take an active management approach. We don't invest based on an index, and we also have additional sources of return that we add to the portfolio to allow the investment experience to be as smooth as possible using all of the key techniques of modern portfolio management.

So we think the mixture of all of those things will bring together a product that really does extract the full value from the hybrid asset class. How we do that is in a number of ways. So when we look offshore, what we find really interesting is that we find a lot of banks with qualities similar to, or in some cases, even better than the Australian banks. 

And that really allows us to build a portfolio that has best-of-breed type qualities. So we can combine banks from different countries, different jurisdictions together, and it provides a much stronger, more resilient portfolio over time. It also doesn't hurt that returns available in offshore markets are generally higher than in Australia. 

And we think that is an additional benefit to adding an offshore element to a hybrid portfolio. In addition to that, as I mentioned, we will add additional strategies drawing on Daintree capital's deep expertise in fixed income markets to add additional return over time, while at the same time adding a hedging capability.

What we've noted in hybrids is that they are very connected to equity markets at certain parts of the investment cycle. And that can cause investment returns to be quite volatile. Using Daintree's proven approach, we will look to minimise those over time to provide a much smoother investment experience for our investors. And looking through that, we hope to achieve a return profile that looks at cash plus 3.5 to 4.5% per annum net of fees inclusive of franking were available.

Now, when we look offshore, the fund is allowed to invest up to 50% of net assets in offshore names. And that just gives us the maximum amount of flexibility to look at the best ideas, be they here in Australia or be they offshore. 

We hope to hold an investment-grade credit rating for the fund as a matter of course. We think there are several opportunities still available in the investment-grade space that allows us to achieve our investment objective with as minimal amount of risk as possible. But we do have the flexibility to look outside the investment-grade range and add additional securities where they make sense for the portfolio overall.

Also, we are going to provide quarterly income and, where there are franking credits available, we'll provide them through to the investors in the normal course. The fund will invest in a range of currencies offshore, but those currency risks will be hedged back to the Australian dollar. So there are no currency risks involved in the fund itself. We will also look to manage the fund to a credit rating, as I mentioned. Generally investment-grade, but we do have the flexibility to look elsewhere. 

And at the current time, the running yield of the fund is sitting close to the 4% mark, which gives some indication of the level of income return that we hope to achieve with the current settings and the current portfolio.

So when we looked offshore, we did quite a bit of work and we found some really interesting themes, especially around quality of some of the issuers offshore. So we did a lot of comparisons and we've just looked at a range of different metrics when we look at some of these large global banks, and the comparisons can be really interesting. 

When we look at CBA, for example, arguably one of Australia's best banks, we can compare it very favourably to several banks in large offshore developed market jurisdictions. And it gives you a sense of some of the opportunities that you can find offshore in large developed markets.

Now, the real interesting point about this though, is that when we look at the yields on offer for specific hybrid securities, when compared to the CBA issue, for example, what you find is that the returns on offer are anywhere between 70 to even more than a hundred basis points per annum of additional return. And to us, that's one of the real key features of the fund. Having the flexibility to look both locally and offshore to achieve that best return profile.

 And looking at a further example, there are simply, hundreds of securities out there that have these characteristics and can potentially offer greater returns than just staying in Australia.

Now, when we look offshore we're taking on different types of risks and investing in different types of markets, and sometimes that pays off. So the fund itself had a particular position in some Canadian banks, for example.

And what we saw in July of 2020 was a change in the rules by the Canadian version of APRA, the banking regulator. And it helped our securities to bounce quite considerably after that announcement because the perception was that the particular type of securities that we invested in were going to be less likely to be extended into the future. And there were more likely other securities that banks could issue over time to diversify their funding sources.

Long story short, the performance was nothing short of spectacular for us, from our perspective. As I mentioned, the types of returns that we are looking to achieve over time are cash plus 3.5 to 4.5%. But those particular securities that I mentioned earlier achieved a return of 42% in the 12 months to July 2021. So a very stark example of what can happen when you do have to those different markets. Sometimes those developments are going to drive positive investment returns in the portfolio.

Now, we're bringing the fund to market in an innovative new structure, and it's called a single unit structure. And what that means is, as an investor, you have the choice to invest in our fund, either through the traditional unit trust method, where you complete an application form, either send it to your advisor or work with your advisor and invest via a platform. 

From the 3rd of November, you'll be able to invest in the Daintree Hybrid Opportunities Fund on the ASX where it'll be listed and trade just like any other share on the exchange. So you can hold it in your share broking account. You can call your stockbroker or advisor and trade it just like any other security.

So definitely giving you the flexibility to really decide which way you would like to invest in the fund. So to summarise, the fund has been designed to achieve a return of cash, plus 3.5-4.5% per annum after fees. And we're going to do that by looking offshore for the best ideas, we're going to take an active management approach, and we're going to list the fund on the ASX to ensure that all investors can access the fund in the way that suits them best.

Unlock the full potential of hybrids with DHOF

The Daintree Hybrid Opportunities Fund (Managed Fund) invests in a diversified portfolio of carefully selected Australian and global hybrid securities to provide a steady stream of income. Find out more.

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