Original article featured in
9 July 2023
Exclusive by Damon Kitney Columnist
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The $8.5bn private wealth management firm Escala Partners is increasing its allocations to high-quality corporate bonds after boosting the value of its specialist fixed-income product offering for wealthy clients, superannuation funds and not-for-profit institutions to $800m.
The Melbourne-based firm, started a decade ago by a group of former UBS advisers led by Pep Perry and chaired by former UBS and Citigroup banker Brett Paton, is now advising its wealthy clients to allocate up to 20 per cent of their portfolios to fixed income products as an alternative to cash term deposits, up from just 5 per cent two years ago.
Escala’s Direct Investment Group, which specialises in fixed-income investments, has slowly built up $800m of bond holdings for clients looking for capital stability, liquidity and income.
A year ago the strategy, which gives clients direct holdings in up to 40 corporate bonds with different maturity dates, was yielding 2 per cent. Now it is yielding up to 6.5 per cent following the steep increases in global interest rates.
Half of the holdings are in A-rated or better bonds issued by the major banks, Macquarie and several large local corporations.
Escala also invests in so-called Kangaroo issues where a global bank – such as the Singapore-based DBS – issues bonds in Australian dollars.
The goal is to return investors at least 200 basis points over the 90 day bank bill swap rate (BBSW). Last month Escala participated in the new ANZ tier 2 issue, which offered a yield of 235 basis points above the three-month BBSW.
“This is encouraging people to go back towards a more traditional asset allocation in their portfolio. Fixed income is now doing what it should. It is providing protection again for when things to wrong, and providing yield,” said Escala Investment director Ben James.
“We think for the next 12-18 months interest rates will be higher for longer and we want our clients to participate in that. We expect to see more funds flow into this product.”
He said the strategy was still focused on floating as opposed to fixed-rate offerings given the prospect of more rate hikes.
Escala’s move is part of a global trend over recent months by wealthy investors to shift money into private credit investments.
In April Blackrock Alternatives’ inaugural Global Private Markets Survey, the fund manager’s first study capturing the views of international capital allocators representing $US15 trillion in assets under management, found the search for income had translated into significant investor interest in private credit.
The survey found more than half of the respondents globally plan to add to their private credit holdings over the remainder of this year, while more than two-thirds in the Asia-Pacific region expect to increase private credit allocations.
Fears about inflation and central bank rate rises have dominated investment markets this year and depressed historic government bond prices.
While corporate bonds carry the risk of company failures, especially in the current tough economic environment, high-quality issues by financially sound firms have continued to generate good yields.
Today there are more than three dozen exchange-traded funds listed on the ASX that focus on fixed income, including corporate, government or a diversified mix of bonds.
More than 60 per cent of Escala’s $800m of bond holdings are held by ultra high net worth individuals (UHNW) and family offices. But the firm’s capital markets head Simon Dawkins said it was now seeing local fund managers using its corporate bond offering.
“We think we are unique in that we have brought this service offering to the UHNW family office market and now a lot of fund managers are using us to manage their liquidity,” he said.
He said the corporate bond offering was also being taken up by not-for-profits.
“What attracts the not-for-profits to this space is the capital stability. It is not volatile, highly rated by the ratings agencies and provides the yield. They are getting a 6 per cent return for a high-grade, single A-rated portfolio. They can see it, kick the bricks, and if they need liquidity it is available,” he said.
Escala now boasts $8.5bn of funds under management, up from $6bn three years ago, and has offices in Sydney, Melbourne and Perth.
Focus Financial Partners, a New York-based partnership of wealth management firms backed by KKR, acquired a strategic stake in Escala in 2019.
Talking more broadly about the outlook, Escala chair Brett Paton said that given the high level of global uncertainty, the firm’s conviction levels were low.
“As a result, we don’t have too many tactical views at the moment. Generally speaking we are cautious on equities and have an overweight fixed-income allocation tilted toward short-dated liquid high-quality credit. We have made sure we have buffers in place, such as a diversified mix of funds in our model and an unhedged currency position in international equities. Our allocation to alternatives also provides diversification against listed markets,” he said.
He said the firm was underweight international equities, especially American markets.
“With the backdrop of a US tightening cycle that has been the most aggressive in several decades, we feel the US cannot reduce inflation to target levels without the unemployment rate rising, which should result in a slump in aggregate demand. A looming recession may result in earnings growth falling significantly,” he said.
Escala’s sector positioning is focused on defensive sectors, real assets and infrastructure, while at a tactical level it is positioning client portfolios towards an overweight position in Japanese equities, via an ETF.
“We believe Japanese equities are presenting an interesting opportunity for investors. After a long period of deflation, inflation is back after successive government efforts,” he said.
Nearly 50 per cent of Japanese companies have net cash on their balance sheets, compared with just over 20 per cent in the US.
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