Morningstar - Q1 2023 - 25

EXHIBIT 1
losses, effectively making total returns the
basis for distributions. The widespread mark-tomarket
capital declines raised the hurdle for
distributing income over this period. (To be clear,
this TOFA election enables funds to largely
mitigate the effect of gains or losses on currency
hedges on distributions, a major reason for
its use.) Those strategies that have not made the
TOFA fair value election and have been unable
to pay distributions underscore the influence of
trading activity (some of which is necessary
as bonds mature) in conjunction with the delicate
initial conditions.
Strategies that couldn't pay a distribution at all
through the first three quarters of calendar
2022 included CC JCB Active Bond, Janus
Henderson Australian Fixed Interest, and Yarra
Australian Bond. Over fiscal 2022, several
others distributed little more than that. The two
outliers in EXHIBIT 1-Janus Henderson
Tactical Income and Altius Sustainable Bond-
each avoided a slump in distributions because
their shorter durations dampened their sensitivity
to sharply rising government-bond yields.
Investors may understandably see these results
and question the role of traditional bond
funds to generate income. But this unfortunate
development will ultimately be temporary. These
funds will accrue coupon income, which will
eventually outweigh realized capital losses and
allow distributions to resume. Estimating
when this may occur is complicated. For starters,
each fund will have its own level of capital
losses to recoup. Moves in interest rates and fund
flows can also influence proceedings.
Further delays could ensue if interest rates rise
considerably or if funds experience sizable
outflows (leaving them with smaller asset bases
from which to claw back the accumulated
dollar value of realized capital losses). On the
other hand, the higher starting point for
yields (especially compared with mid-2021) allows
more leeway to withstand such moves.
Meanwhile, many credit and unconstrained
fixed-income strategies encountered much less
disruption to distributions during 2021-22
( EXHIBIT 2 ). This shouldn't be too surprising.
Many had a higher starting yield than traditional
Income Distributions by Australia Bond Funds
10%
4
6
8
2
2018
Source: Morningstar Direct. Data as of Nov. 16, 2022.
2
2018
EXHIBIT 2
Income Distributions by Diversified Credit and Unconstrained Bond Funds
12
15%
15%
6
9
6
9
3
2018
3
2018
Source: Morningstar Direct. Data as of Nov. 16, 2022.
2019
2020
2019
12
2.62%
AB Dynamic
Global Fixed
Income
2.62%
AB Dynamic
Global Fixed
Income
2020
0.94%
Payden Global
Income
Opportunities
Opportunities
2021
0.94%
Payden Global
Income
2021
0.00%
Franklin
Templeton
Multisector
Bond
0.00%
Franklin
Templeton
Multisector
Bond
2022
2022
2019
2020
2021
2022
2019
2020
2021
10%
4
6
8
3.68%
Janus
Henderson
Tactical
Income
3.68%
Janus
Henderson
Tactical
Income
4.36%
Altius
Sustainable
Bond Fund
4.36%
Altius
Sustainable
Bond Fund
2022
Australian index-relative portfolios leading into
the second half of 2021, mainly by taking more
credit risk). Drawdowns were also often shallower
by virtue of having less interest-rate risk.
Distributing income under these circumstances
doesn't make these strategies better than
the group of index-relative funds. Rather, it
underlines the difference in risk characteristics. In
this case, sharply higher government-bond
yields caused problems for duration-sensitive
funds; a severe risk-off event may prove
problematic for more credit-oriented portfolios. For
example, AB Dynamic Global Fixed Income
and Payden Global Income Opportunities didn't
distribute any income during the first quarter
of 2020 when the coronavirus pandemic struck.
Meanwhile, ongoing struggles in emerging
markets have caused Franklin Templeton
Multisector Bond to hemorrhage losses and
distribute little income from 2020-22.
For those who prioritize income, being attentive
to the different factors that can affect distributions,
both within and outside a fund manager's
control, can help set appropriate expectations
when unforeseen circumstances materialize.
Tim Wong is director, fixed-income strategies, manager
research at Morningstar Australasia.
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