Fixed Interest
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Short-Term Strategy Short Term Fixed Interest Trust Diversified Strategy Two-Year Diversified Fixed Interest Trust Five-Year Diversified Fixed Interest Trust1 AUD class Five-Year Diversified Fixed Interest Trust1 NZD class |
Overview
Two factors explain the majority of returns of a fixed interest portfolio. The quality factor describes how low-grade obligations have higher expected returns than high-grade obligations. The term factor describes how long-term bonds have higher expected returns than short-term bonds. Dimensional believes, however, that these premiums have not been large enough historically to reward the additional risk. Therefore, fixed interest is best kept short in maturity and high in credit quality so investors can focus on the much higher equity market return factor.
In implementing our fixed interest strategies we employ a "no interest rate forecasting" investment philosophy. This philosophy is based on original research by Professor Gene Fama, which concluded that fixed interest markets efficiently price securities. It found that the best estimate of future yield curves is today's yield curve. This does not mean that the current curve will not change but that the changes are unpredictable.
Given the no-forecast approach, the issue becomes one of exploiting opportunities offered by the current yield curve. Dimensional calculates expected horizon total returns, including income and capital gains implied by the yield curve. To maximise expected returns, Dimensional chooses shorter maturities in flat or inverted yield curve environments and longer maturities in upwardly sloped curves.
Dimensional's variable maturity fixed interest strategies are focused on yield curve management, the core of Dimensional's expertise in fixed interest. This no-forecast strategy seeks to maximise expected returns by determining the optimal maturity choice and holding period under the current yield curve. Maturities are shifted in response to changes in the yield curve when the increased expected return offsets trading costs. Dimensional's belief is that high-quality; highly liquid securities are efficiently priced by the market.
Short Term Strategy
DFA Australia launched the Short Term Fixed Interest Trust in 1999. It is designed to generate income and dampen overall portfolio volatility.
The Short Term Fixed Interest Trust invests in high credit quality, Australian dollar denominated domestic securities with a maximum maturity of 2 years. The Trust's weighted average maturity target is 1 year.
Diversified Strategy
DFA Australia launched the Five-Year Diversified Fixed Interest Trust1 AUD class in 2001 and the Five-Year Diversified Fixed Interest Trust1 NZD class in 2004. The Two-Year Diversified Fixed Interest Trust was launched in 2005. These strategies are designed to generate income and dampen overall portfolio volatility. The Two-Year and Five-Year Diversified Fixed Interest Trusts invest in high credit quality domestic and global fixed interest securities hedged to the Australian dollar with a maximum maturity of 2 years and 5 years respectively. The Five-Year Diversified Fixed Interest Trust1 NZD class is hedged to the New Zealand Dollar with a maximum maturity of 5 years.
Country allocation decisions are based on expected returns given current local yield curves. The objective is to provide a fixed interest investment that dampens portfolio volatility, we maximise the country diversification through the equal weighting of country allocations (subject to some country limits). Allocation shifts away from equal weighting are regarded as a reduction in diversification and require an expected return premium to compensate for this reduction. The exception to equal weighting arises when yield curves are inverted and cash offers the highest returns. In this instance, there is no benefit from holding cash in multiple countries and so the allocation might be invested 100% in Australia.
The Diversified Fixed Interest Trusts provide greater risk and a higher expected return than the Short Term Fixed Interest Trust.
1 Formerly known as Diversified Fixed Interest Trust.