Evidence clobbers opinion for Macquarie's fixed income king

Almost five years ago to the day, Macquarie's head of fixed income Brett Lewthwaite took the stage in front of a packed audience of financial advisers.

He had a tough act to follow. Star fund manager and headline act Hamish Douglass had just outlined to the Portfolio Construction Forum why we were in the midst of a bond bubble as he branded the "lower for longer" thesis "absurd".

But Lewthwaite was not swayed. There was simply too much debt in the system to support higher interest rates. The chances of a sustained inflation outbreak were slim to none. Yields were going nowhere but down.

Five years later, it is fair to say the bond guy won that debate.

The lucrative consolation for Douglass, which he recognised at the time, was that investments in consumer staples and tech stocks – would be bid up further in a low rate world.

Lewthwaite says his call wasn't down to boldness, it was the result of a years-long evidence-based approach to investment embraced by the Macquarie fixed income team.

"Do the work, do the research and truly understand the risks we are facing," he said.

"There is a compulsion in funds management to tell people what they want to hear," Lewthwaite tells The Australian Financial Review.

"But we can't do that. We were just presenting the evidence. I'm not here to be popular and tell you what you want to hear."

And what people did not want to hear was that the global economy would be weighed down by debt and demographics well into the future.

While the view that bond rates would be stuck near zero is now well entrenched, it was met with untold resistance in the aftermath of the global financial crisis.

The $16b moment of truth

In fact, in 2010 a long list of prominent US economists voiced their objections to the Federal Reserve's unconventional monetary policies warning it would drive up the supply of money and trigger a destructive inflationary outbreak.

And many experienced Australian bond fund managers fought the bond market rally by cutting exposure to falling interest rates.

Lewthwaite says he and his long-time colleague Dean Stewart deferred to an evidence-based approach to managing fixed income after inheriting control of the division in around 2004.

Lewthwaite had spent the previous 10 years at Bankers Trust working alongside fixed income luminaries such as Stephen Miller and Susan Buckley before moving to Macquarie Investment Management in an investment specialist role.

But when a trio of managers left to join Perpetual he resumed a portfolio management role alongside Stewart.

"Instead of coming in every day and saying to ourselves 'let's just back ourselves with our intellect and our skill', we tried to work out exactly what we needed to do to create sustained success," he says.

We have never felt excited or celebrated. We felt 'we have to deliver' and that pushed us further into the work.
— Brett Lewthwaite, head of fixed income at Macquarie.

The key moment for the Macquarie team came during the global financial crisis, when the team became concerned about the state of the credit markets and began cutting corporate debt positions.

"We lived and breathed it. David Hanna [the senior credit analyst] and I were rotating.

"We would be there together all day and one night he would take [the evening shift], the next night I would take it."

Heading into September 2008 the flagship fund had moved into 43 per cent cash.

The result of their management meant they emerged with their credibility enhanced, and with $16 billion in new client mandates.

"We have never felt excited or celebrated. We felt 'we have to deliver' and that pushed us further into the work."

And that work was to take a long-term view on global interest rates.

Demographics and debt

They looked at the structural features "haunting the global economy – such as demographics and debt" – and reached the conclusion that rates were going to stay low.

And they've been proven right.

"Every time inflation pops up, yields pop up, it hits the debt, the debt hits the economy and everything rolls over again. We've seen it three or four times now."

Support to stimulus

Their consistent performance has meant they have attracted and retained clients.

Macquarie's Australian fixed-income funds under management has grown from $25 billion 10 years ago to $75 billion today, with $210 billion of funds globally.

But what about now? The Federal Reserve appears to be trying to usher in a new regime where it will go even further in attempting to stoke inflation.

"The first reaction is 'what, well great you've been trying to do something for a long time and you haven't succeeded, and now you're going to try to do it even more'."

They also have to be alive to the prospects of new paradigms in monetary policy such as Modern Monetary Theory gaining traction.

Lewthwaite says the team is constantly testing its views and recognises that even if they believe something won't happen "it doesn't mean the world is not going to fall in love with the idea it might".

He sees struggles for the global economy as it recovers from the COVID-19 shutdown.

"The economy has been rebounding but it is starting to slow. To get back to where we were is numerous quarters away and from here it's a bit harder going."

Central banks, he says, will do what they can via quantitative easing, but that won't do much more than lift asset prices. That's marginally helpful but it is "main street that needs to benefit".

"The question becomes how does fiscal policy continue, and turn from supporting to stimulating the economy? This is what governments have struggled with."

That leads to another important question: how will fiscal policy be deployed – will it be in the form of business tax cuts or increased welfare distribution?

In this context, the looming US presidential election will be key.

"The worst-case scenario is 'a too close to call' result – which is neither party being able to enact what is required," Lewthwaite says.

Lewthwaite has more hope for Australia and says the extent to which the banks, customers and policymakers have worked together in the past is underestimated.

Central bank purity

His views were formed as a teenager growing up in the northern suburbs of Sydney in the late 80s where "for sale signs popped up all over the place" as interest rates hit 19 per cent.

"What happened is the banking system went – 'OK what can you pay so that we keep you in the home? We will capitalise the interest on your mortgage'."

And he is full of praise for the Reserve Bank who he says is the closest thing to "a pure central bank that has got its head clearly where it needs to be".

"They don't necessarily wake up every day and look where the ASX is. This doesn't seem to be a concern to them.

"What is a concern to them is growth, jobs and inflation and enacting policy in a very sensible way."

The Reserve Bank he says recognises that "QE doesn't necessarily lead to better economic outcomes or inflation outcomes".

Overall he believes Australia is well placed to deal with the inevitable challenges that lie ahead.

There's co-operation among the banks, the Treasury and the regulators to navigate through the crisis. While government debt capacity, sovereign capital and a large pool of funds in the superannuation sector means there's latent firepower.

"I look at that collective, and that co-ordination, and even though there's always going to be friction, the potential to do things that are good for this economy is quite significant."