Yarra Capital: Where to invest as growth slows

Rain, hail or shine, investors must make investment decisions for the betterment of their holdings. But when a record bull market looks set to falter, hitting another hole-in-one suddenly becomes a bit more challenging. 

Alternatively, you can embrace the volatility and seize any opportunity that comes your way. This phenomenon is on the horizon, says Roy Keenan, Co-head of Australian Fixed Income at Yarra Capital Management. His team has been factoring inflation into their forecasts since COVID-19 arose, and we are now seeing the results filtering through via the Fed and the RBA lifting interest rates. 

From the beginning, it was pretty clear to us that the Fed was going to be raising interest rates. Our house view for two years has been that there's an inflation problem globally. And this year was going to be where both the Fed and the RBA started to ease off monetary policy stimulus. So for us it was about understanding how the market will react

This will have marked impacts on global growth as financing costs rise steeply in order to combat inflation. But restricted growth paves the way for generational buying opportunities in markets - going into these environments with experience and conviction is the key.

So in some ways, you probably don't wish for volatility, but in my case, I actually thrive on it because I think you can actually identify things in the marketplace that look cheap.

In this interview, Keenan reflects on how his extensive experience in markets has prepared him for what is currently unfolding and discusses Yarra's interest rate forecasts, domestic market outlook and the rising opportunities in credit markets. Finally, he also shares a special 'Stats Incredible' that is definitely worthy of a Green Jacket. 

Transcript has been edited for clarity

Reflecting on your 30 years of experience, do you see any parallels to what we are currently seeing in markets?

I'm a calendar person, so at the start of the year I tend to think, "What's this year going to look like? How does it play out?"

From the beginning, it was pretty clear to us that the Fed was going to be raising interest rates. Our house view for two years is that there's been an inflation problem globally. And this year was going to be where both the Fed and the RBA started to ease off monetary policy stimulus. So for us it was about understanding how the market will react 

The circumstances reminded us of the dot com boom, which meant that as interest rates rise this year, it's going to be very similar to that 2001-2002 period, putting pressure on valuations, particularly in equity markets. As interest rates rise, the long end of the yield curve is going to rise, and that would actually start to stretch equity valuations. 

From my viewpoint, it was, "Well, how does that play out for credit?" Sometimes people say that markets are correlated. They're not always correlated. They've been correlated off the back of QE over the last number of years. From a credit point of view, our view has been that credit will do pretty well in this environment because, fundamentally, growth still looks pretty robust.

For the remainder of 2022 and into 2023, our view is that while growth held up, credit will sail through this period quite well, whereas equities might get a few headwinds from rising interest rates. 

What will be the most enduring issue facing markets in 2023 and beyond?

I think there's no question: it's how high will interest rates go. If I just refer to the Reserve Bank, it was probably only four or five months ago that they were saying there would be no increase in interest rates till 2024. It seems like a lifetime ago that was occurring. But we all know now that there are interest rate rises built into the economy. The US Fed also has many increases built-in. 

For us, it's all about growth. We want sustainable growth for the companies that we invest in. From my point of view, I ask if the Fed and the RBA tighten so aggressively off the back of the Ukraine crisis, rampant inflation, supply chain constraints etc., does that actually fundamentally slow growth, or does it lead to a recession? And that's the thing that we're watching for 2023 and beyond. 

But I would also say off the back of that, Australia seems really well placed - in comparison to the US - to ride out that volatility that we may see. Australia has just got a better starting point from an inflation and wages perspective, as well as the ability of a government to support the economy if something does go wrong. 

With the US Federal Reserve commencing rate rises, what does this mean for credit markets?

It's not only about one rise; it's about how much the market's forward-looking on interest rates rising. Today, we are talking about the Fed moving short term interest rates and normalising them at around 3.5%. If that were to eventuate, I would imagine that growth is going to be slowing pretty hard. So that's the key concern for us. If we bring that back to Australia, we've got a situation today where the RBA has not had inflation back to its target since 2014. Whereas in the US, inflation has been above its target since 2018. So, domestically, we just have that better starting point to manage the growth-inflation trade off in Australia. That probably makes Australia look like a bit more of a safe haven from a credit interest rate perspective, but also from an equity markets perspective.

Are there opportunities arising in credit markets at the moment?

Going back six months ago it was a tough market for credit investors to find value. Today, the more volatility, the more value that we can find. 

So in some ways, you probably don't wish for volatility, but in my case, I actually thrive on it because I think you can actually identify things in the marketplace that look cheap. 

One of the things today that is interesting is that we have quite a steep yield curve (cash rate to 10-years), but we also have steep credit curves. And I think the one thing that I would point out there is that the combination of the two means that we can invest into, as an example -  a Sydney toll road like WestConnex. They're BBB+ rated by Standard & Poor's. So high-quality, investment-grade company. We can invest for 10 years and get a yield of 5.3%*. Compared to a similar investment six months ago, where you could probably only pick up somewhere in the order of 3%, that looks really good value today for such a high-quality credit.

Those are the sort of things that are starting to come onto our radar because the one thing you will know from longer-dated credit, is that at some point the Fed and the RBA will probably take the tightening of monetary policy too far, which means that inflation will start to come under control, and the long end of the yield curve will start to look attractive again. We've definitely got our antenna up to look for those opportunities to add value to our fund.

Do you have an incredible statistic to share with us?

I've probably got an interesting one because I'm addicted to markets, but I'm also addicted to golf. It's probably not great from an ESG perspective, but I read recently that in the US, American golfers lose over 300 million golf balls a year. So what's bad about that from an ESG perspective is that it takes around a hundred to a thousand years for a golf ball to decompose, which can't be good for the environment. Unfortunately, every weekend I tend to contribute to those lost golf balls, so, I'll have to make a better effort at keeping it on the fairway in the future!

*with markets having sold off, the yield on WestConnex is now 5.9%.

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The Yarra Enhanced Income Fund seeks to deliver higher returns to investors than traditional cash management and fixed income investments. Learn more via the Fund profile below, or by visiting Yarra Capital's website. 

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