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Mani from Copia sits down with Wayne Buckingham, Managing Director of Mutual Limited, to discuss the rising interest in credit and high-yield investments, as well as Mutual Limited’s expertise in the space. Wayne explores the appeal of Aussie dollar credit as a liquid alternative to private credit, emphasising Mutual Limited’s disciplined investment approach. He explains how the firm prioritises transparency, stability, and contractual obligations while avoiding the risks associated with private credit. With a strong focus on liquidity and risk management, Wayne highlights how Mutual Limited carefully selects investments to ensure consistent valuations and long-term security for investors. Watch the full discussion below.

Understanding market uncertainty in 2025 as interest rates, inflation and trade tensions create new risks for investors. As we move through the early stages of 2025, I want to highlight a couple of broad themes I think will influence markets through the year. No table thumping, frothing at the mouth predictions per se, but rather the core influences driving the narrative, and in turn themes investors need to consider when allocating their capital across various asset classes. At the very top of matters for consideration is the degree of uncertainty over the year ahead. Before heading into the two core themes, it’s worth pausing to take stock of where we’re starting the year from. Stocks valuations are elevated, priced to perfection almost, with core indices near historical highs. Bond yields are within the top quartile of recent trading ranges, and well above post GFC averages, arguably back toward ‘normal’ long run averages. Credit spreads on the other hand are in the neutral zone, neither historically cheap nor expensive. On the data front, domestic growth is anemic, at its slowest pace since the early 1990’s (excluding the pandemic) and only propped up by government spending and population growth. Domestic inflation is trending in the right direction, but there are potential obstacles ahead that could disrupt the trend. The jobs market remains resilient, which is making the case for rate cuts a challenge to argue. The under-pressure A$ is certainly not helping the cause – a weaker A$ is inflationary, all other things being equal. I’ve listed the themes in order of importance, as I see them here and now. As the year progresses though, influences will wax and wane as data is released, policies are formulated, events unfold, markets grow or shrink, and politicians speak. The focus here is on Mutual Limited’s sandpit, bonds and credit, but I’ll touch on stocks for what it’s worth. Number One: Monetary Policy Normalisation Probably the theme closest to many households’ hearts, monetary policy normalization. In laymen’s terms, when will the RBA cut rates, and by how much? The RBA has hiked rates by  +425 bps since the first half of 2022 in a bid to combat inflation, which remains a work in progress. While peer central banks around the world have cut rates by anywhere between 100 bps and 135 bps over the past six-months or so, the RBA has been resolute in leaving the cash rate unchanged. The RBA next meets on February 18th, which at this stage is considered a ‘live’ meeting, meaning there is a decent chance of a change in policy. Following the most recent CPI data (Q4 2024) market pricing indicates a 92% probability of a 25 bp rate cut, taking the cash rate down to 4.10%. Consensus among market pundits is leaning in the same way regarding the timing of the first cut, although there are a few stalwarts still thinking an April or May cut more likely. I’m being a bit of a stick in the mud, I think the RBA won’t cut at the February meeting. I accept that this is a somewhat risky call in the face of consensus views. While inflation data supports a rate cut, labour data doesn’t. Also contributing to my stance in the mud, is the risk to global inflation from US-instigated trade wars. Closer to home, we have a Federal Election by mid-May (yet to be called), which will likely to be fought on cost-of-living grounds, i.e. I expect more government spending than less. Government spending is already elevated by historical averages, representing a challenge to the RBA’s inflation fighting agenda. And lastly, there is the weaker AUD, which is inflationary all other things being equal. Having said all that, I am emotionally prepared to be proven wrong. Looking ahead, whether or not the RBA cuts in February, markets are pricing a cash rate of 3.60 % by year-end, suggesting three cuts. The consensus median is a touch lower at 3.60%. While much will depend on upcoming data and potential events already discussed, I’d say we’ll see one cut at worst, with two at best, taking the cash rate to around 3.85%-4.10% by year end. Beyond that is pure guesswork. Number Two: Fiscal Policies, Deficits, and Threats to Inflation   The second theme is pretty broad—namely fiscal policy and its implications for inflation and bond yields. Arguably, themes one and two are akin to the chicken-and-egg argument, but for now, the order I’ve presented feels right. We’ve seen the impact of government spending on inflation across the domestic economy, which is a contributing factor to why the RBA has lagged their global central bank brethren in cutting rates. Government spending in Australia as a percentage of GDP sits around 28%, well up from historical averages of 22%. The RBA has spoken of the relatively rapid growth of public final demand (government spending) as a contributor to excessive aggregate demand, which, in turn, impacts inflation.   Another implication of higher government spending—particularly when there is no corresponding increase in government revenues, is the need to fund it. If spending exceeds revenues, deficits arise, requiring funding through increased government borrowing. Rising deficits place upward pressure on bond yields, which in turn increases cost of borrowing for businesses and households. The Australian fiscal deficit is currently manageable at 2.1% of GDP. Where it’s more a problem is in the US, where the deficit is ~6% of GDP, with expectations it’ll get worse under the Trump administration given stated policies. Local bond yields and their direction are closely aligned to US Treasury yields, as displayed in the following chart.   In addition to the likely growing US government debt burden and associated pressure on yields, we also have the prospect of old-fashioned tariffs on the US’s core trading partners: Canada, Mexico and China, among others. China is closest to our economic hearts as our largest trading partner (29% of exports). Any threat to China’s growth prospects will weigh on our own growth hopes to some degree. Commodity prices would likely suffer, which could trigger further weakness in the AUD. This would cushion local exporters, but at the same time be inflationary for consumers and households. China may counter US tariffs with stimulus packages or imposing their own tariffs on US goods, but at this stage it’s all an unknown, and that is the risk in itself. Outlook: What Are the Risks?   Bonds   Much depends on what the RBA does this year, but the outlook for rates and yields is lower, but not as low as the prior cycle. Given inflationary risks, the easing cycle is expected to be relatively short and shallow, possibly two cuts bottoming out around 3.50% vs 0.10% through the prior ‘extraordinary’ cycle. Bond yields will likely end the year lower than they are now, with three-year yields to trend toward 3.60% - 3.80% vs 3.82% now (January 31st), while ten-year yields will fall to a range of 4.00% - 4.20% vs 4.40% now. Risks to the downside would be triggered by a material drop in growth and softening labour markets, while risks to the upside could come from resurging inflation following Trump’s tariff plans.   Credit   Credit spreads entered the new year at neutral levels, within striking range of long run averages, but still above pre-COVID levels. Investor sentiment remains constructive. The A$ credit market — the traded market at least — is very much an investment grade market, with strong underlying fundamentals. The ‘private credit’ market, which has attracted some negative press of late, is down the riskier end of the spectrum, again as evidenced by some recent events. The main threat to credit spreads – i.e., a material widening, would be a systemic event akin to the pandemic, GFC, or something of equal significance. A low probability event, but one that brings high impact consequences. Elevated issuance could also impact spreads, but with lending growth running at just above average, any new issuance should be comfortably absorbed without any undue stress in spreads. We expect spreads to remain range bound.   Stocks   Not my wheelhouse per se. I have no street cred when it comes to stocks, so take my views with a grain of salt. For me, stock valuations are on the frothy side, and indices are close to historical highs despite the recent aggressive run up and known unknowns ahead. Sure there are some single name nuggets of gold, but market wide, I see more reason for markets to disappoint than not. We would need to see some aggressive earnings growth to justify current valuations and it is hard for me to gain confidence we’ll see such growth. If I were handed $1m today to invest, I’d put only a token amount in stocks. Buyer beware.

Bank hybrids are set to die a slow and lingering death in the wake of APRA deeming the securities no longer fit for regulatory purpose. They’re to be phased out by 2032, to be replaced by a mix of predominately tier 2 capital (subordinated bonds) and a sliver of common equity, for the majors at least. Regional banks will have to settle for just tier 2. I have commented on the initial proposal and details in the past, see here  for a refresh. The phasing out of hybrids will leave a $43bn hole in investors’ sandpit of investable options, particularly the corner of the sandpit set aside for investments held for their income generating capabilities while exposing investors to only modest capital volatility. The first stage of this process kicks off shortly with just under $1bn of ANZ hybrids set to be called in March 2025, and a further $4.2bn to be called by the end of the year. What alternatives can investors consider? Will the regulatory capital set to replace hybrids, namely tier 2, do the job? Not for retail investors, no. Tier 2 is a wholesale market product, with retail investors not permitted to play (directly). There are limited fund options, not pure tier 2 funds at least. Nonetheless, the return dynamics are different. The spread offered on bank hybrids have average around +290 bps over the past five-deals, whereas average tier 2 spreads on the other hand have been around 100 bps lower, at around +190 bps (past five-deals). Is an increasing allocation to bank stocks an option? It’s always an option, but is it a prudent one? The decision here is nuanced, and would be a function of an investors age, investment horizon, risk appetite, existing bank stock allocation and so on. Generically though, a relative increase in allocation to stocks in place of prior hybrid allocations would increase portfolio risk, all other things being equal. Over the past five years, and probably longer, volatility of bank stocks (price), on a month-to-month basis, has been four times that of hybrids (price). Yield wise, hybrids are yielding over 7%, and in some instances as much as 8%, whereas major bank dividend yields are around 4% - 5%. An important consideration for a hybrid investor considering allocating into bank stocks is the prevailing ‘frothy’ valuations, particularly CBA and WBC. Over the past 12-months prices have risen +37% and 40% respectively. Impressive, especially given pre-provision earnings fell through FY24 and expectations for earnings growth over the year ahead are a modest 2% - 4%. NAB (+23%) and ANZ (+14%) have seen more muted price performance, but still robust nonetheless, especially compared to the broader ASX 200’s gains (+12%). Why the run up in bank stocks? One possibility is a rotation out of materials given China growth concerns. The ASX 200 Materials Index is down -7% over the past year. While bank stocks present capital risks (i.e. a correction toward valuation ‘norms’), it is challenging to identify the catalysts – probable ones at least – that could trigger a sell-off. Nonetheless, it’s a risk worth considering, and yields are less than compelling either way. What about deposits? Prudent, but not a like for like alternative given the spread differential, i.e. close to 300 bps. Next. I have previously provided some thoughts here  on potential alternative investment options, notably Residential Mortgage-Backed Securities (‘RMBS’) and Asset Backed Securities (‘ABS’). As per the attached note, these are not an asset class available to retail investors but accessible through managed funds nonetheless. I won’t re-hash what I have previously written, but rather highlight the continued strength of the RMBS / ABS market. Last year saw $80bn of RMBS and ABS issuance in A$, across 100 individual transactions from 57 organisations. A record year, comfortably exceeding prior peak water marks ($64bn). This also represents more than triple the average annual volume of major bank debt issuance. And here’s the marketing pitch. At Mutual Limited we have two retail funds that invest in RMBS and ABS. Both fund’s core focus is steady income generation with capital stability, arguably the same dynamics that drew investors to bank hybrids. The first of these two funds is the Mutual Credit Fund, which can have up to 30% allocated to RMBS and ABS, while the balance is predominantly across floating rate debt issued by APRA regulated entities. The fund returned +8.37% (net of fees) for the year ending December 31st, with a prevailing yield to maturity of 6.44%. Next is the Mutual High Yield Fund, which has a larger allocation to RMBS and ABS, typically up to 75%. This fund returned +11.86% (net) over 2024, with a prevailing yield to maturity of 8.56%. For details on these funds, and our other two funds, please visit our website here . Both funds delivered monthly returns with materially less volatility than hybrids, 0.39% for MCF and 0.56% for MHYF vs 7.35% average for major bank hybrids. Before closing off, other alternatives are coming to light also that merit comment. In recent weeks we’ve seen the launch of a couple of Listed Investment Trusts, or LITs, which has attracted some attention in the financial press, see here AFR: Race is on to plug $43bn bank hybrid market . LITs have been around for a while, but have not necessarily caught on with retail investors, not in scale at least. Nevertheless, a few new LIT’s are being marketed around, ostensibly structured in such a way as to replicate hybrid type returns. All I’ll say is be wary of transparency, underlying credit quality, and fee structures. Do your due diligence.

The main event for November was the US Presidential Election outcome. It was a ‘Red Sweep’ for the Republicans, regaining control of the Senate, the House, and of course the Presidency. Stocks surged on the result as Trump is seen as ‘market friendly’. Domestically, the RBA November meeting outcome was as expected, with the cash rate left unchanged. The statement was probably still on the hawkish side of neutral, which surprised some, with the board reiterating “whatever is necessary” to return inflation (trimmed) back to target ranges. Towards the end of November the months long spread compression in tier 2 finally cracked, with spreads drifting wider. Click below for monthly reports: Mutual Cash Fund Mutual Income Fund Mutual Credit Mutual High Yield

Scott Rundell, CIO of Mutual Limited, provides an update on the market implications of Donald Trump’s re-election as US President. Scott discusses the potential impact of Trump’s key policy proposals, including steep trade tariffs, corporate tax cuts, deregulation, and controversial immigration measures. While US equity markets have rallied on expectations of tax cuts, inflationary concerns from tariffs are driving bond yields higher, adding uncertainty around future interest rate cuts. For Australia, Scott highlights the risks tied to US-China tensions, which could affect exports and inflation, as well as the broader economic outlook. He also emphasizes the long-term uncertainty around Trump’s ability to deliver on these policies, underscoring the difference between campaign promises and governance. Watch the full update below for more insights.

Trump is president of the US again, his second bite of the cherry after a brief four-year interlude playing golf and ducking and weaving court cases. Despite expectations of a close contest, the result was a comprehensive ‘Red Sweep.’ Trump won all seven key swing states, and the Republicans regained the Senate and maintained the House. Consequently, Trump has a clear runway to implement policies without the need for bipartisan support. The question is, will he? Will campaign promises and policies be implemented? If last time around is anything to go by, no, not completely. According to www.politifact.com , Trump kept 23% of his 2016 campaign promises, compromised on a further 22% promises, and broke 53% promises (not sure on the other 2%!). Obama kept 48% of his promises, compromised on 28%, and broke 24%. Having said that, the last time Trump was elected he was a newbie in the role and encountered more political headwinds than he probably expected, hampering his policy agenda. This time around, he’s ‘battle hardened’ and has surrounded himself with loyalists rather than selecting from within the party ranks. Under Trump, economic nationalism will replace globalisation. Tariffs of 10% - 20% are proposed on all imported goods & services, with 60% on anything from China. The aim is to make more ‘stuff’ in America. While Trump will likely impose tariffs as proposed, there will be concessions. Negotiations will be had, deals will be done, it’s his way. Most tariffs will likely be targeted at trading partners that the US has a deficit with, or where US industries compete against. In the case of China, one of their top three trade deficits, the tabled 60% tariff is likely an ambit-claim ahead of broader negotiations. Trump has promised to extend tax cuts he enacted when he was last president, which are due to expire next year. Further cuts are likely. The corporate tax rate went from 35% to 21% in 2016 (vs a policy target of 15% at the time). He’s promised less red tape and to reduce regulatory hurdles, particularly in banking and the resources sector. Lastly, he has committed to tearing up the Paris Agreement. Illegal immigration was again a key plank in his election platform, with mass deportations of illegal immigrants on the cards. There will likely be a flow-on effect in labour markets, i.e. less cheap immigrant labour, which again is inflationary. I’m not going to dwell too much on this policy here. While there will be some economic impact, it’s more a domestic policy with less tangible global or market implications. On the geopolitical front, Trump has promised to end the Ukraine war, not sure how though. He has threatened to walk away from NATO if member nations don’t begin pulling their weight on defence spending (cue higher debt issuance to fund military upgrades). Taiwan is also on notice. At the end of day, Trump is a businessman. For Trump, everything is a transaction. Traditional alliances are likely expendable, particularly if it’s for the benefit of the US. Are there any market lessons from Trump’s first presidency in 2016? Trump is Trump. He still shoots from the hip, frequently heading off script and proclaiming broad policy ideas without thought for the details. He is still very much pro-growth, which is evident in his enduring policies of further tax cuts, broad based trade tariffs, and plans to deregulate key sectors. When last elected, US stocks rallied over the following year (tax cut hopes), while bond yields rose (reflecting likely inflationary pressures). At the time the S&P 500 was trading at a forward PE ratio of 18.3x (vs 10Y average of 15.2x). Over the first 12 months on from winning the presidency, S&P 500 gained +21.1%. This time around, the S&P 500 is trading at far loftier valuations, with forward PE of 24.9x and the index sitting at all time high. At face value, given the already elevated starting position, and much higher bond yields, repeating 2016 – 2017 gains this time around will be more challenging. A big advantage is the fact that other markets, such as Europe, UK, and China have broadly weakened on their own softening growth outlooks compared to 2016 - 2017. Trump’s trade policies will only exacerbate their problems. As such, on a relative basis, global investors will likely be attracted to US markets over others. In fixed income markets, US treasury yields rose ~60 bps (from 1.80% to 2.40%) over the year to November 2017, with the majority of increases coming in the first month or two after the election. A month after Trump was elected, the Fed hiked rates 25 bps, and then seven more times after that over Trump’s presidency, up to 2.50%. Then COVID hit and emergency cuts were enacted. Similarly, treasury yields are much higher this time around, with 10Y yields around 4.30%, up 75 – 80 bps since the middle of September, arguably already pricing in inflationary pressures from the election outcome. How much further they go will be dependent on fiscal stimulus and inflation triggered by the foreshadowed trade wars. It’s likely yields will trend higher over the coming year. A key point of difference now vs then is the macro starting point. Inflation was well under Fed targets in 2016 (US CPI at 1.6% YoY vs +2.0% YoY target) and official cash rates were at or near all-time lows (Fed Funds Rate at 0.50%). Today inflation (core US CPI at +3.3% YoY) is well outside target ranges and official rates are materially higher (Fed Funds Rate of 4.70%). US growth (real GDP) was +1.80% YoY in 2016, rising to +2.50% YoY in 2017, and +3.00% YoY in 2018. Growth moderated in 2019, to +2.50% YoY before COVID hit. This time around growth is at a better starting point, +2.80% YoY, with more fuel to add to the fire once Trump’s slides his feet under the Resolute desk in January next year. What can we expect from here? In a word, uncertainty! The big unknown is policy reality vs campaign policy promises. How much will be formalised into policy. I’d suggest more than last time, but not as far as proposed. Having said that, he has spent a lot of time promoting tariffs, far more than he did heading into his first term. He has clearly become a lot more infatuated with tariffs as a policy. The details, however, do not appear to have received a lot of attention, and this is where the uncertainty comes from. Further complicating things, how will America’s trade partners respond? His policies are inflationary and pro-growth, will the latter compensate for the former? While stocks will likely trend higher in that environment, treasury yields will also head north through 2025 and end higher than where they started. Further, I’d suggest the scale of expected rate cuts from the US Fed will continue to be pared back as policies are formalised and the Fed assesses the likely economic impact. Trump is appointing loyalists to key roles rather than Republicans, which likely reduces any moderating influences vs last time. US stocks have jumped out of the gate, with underlying corporate margins expected to benefit from proposed tax cuts, deregulation, and higher tariffs, at least in the near term. However, there are plenty of potential negatives the market seems to be ignoring as well. Specifically, the impact of tariffs on inflation and the impact on labour supply from mass deportation of illegal immigrants. Elsewhere, gains have been much muted as Trump’s policies will likely weigh on trading partner growth amidst their own existing challenges, i.e. Europe and China. Australia holds a trade surplus with US, but are heavily leveraged to China, which creates challenges. And for Australia? Any hit to China growth will weigh on the local economy, so trade talks there will be closely watched. The AUD is expected to weaken as a consequence of high treasuries and weakening commodities outlook on waning China growth, which will weigh on mining stocks. Global inflation will hamper the RBA’s inflation finding agenda, with the very real prospect of no rate cuts until well into the end of the year, or even into 2026. Credit spreads are tightish, so any shocks or surprises could cause some widening pressure, but momentum right now is sideways to slightly tighter. As with stocks, we’re starting at a point in the cycle where there is less of a buffer to absorb surprises.

We’re excited to share that in its latest review, Lonsec has rated all Mutual Limited funds as “Recommended.”   The Mutual Income Fund, Mutual Credit Fund, and Mutual High Yield Fund each received ratings upgrades, joining the Mutual Cash Fund, which retained its Recommended rating.  Key Findings   Lonsec highlighted that all three upgraded funds “exhibited strong performance whilst achieving internal objectives and outperformance relative to the Lonsec peer group.”  In its report on the Mutual Income Fund, Lonsec noted, “The catalyst is the increased conviction in the team’s resourcing and process given its narrow investable universe of securities issued by Australian ADIs, and its ability to achieve the investment objectives consistently.”  Managing Director Wayne Buckingham commented:  "We are honoured by Lonsec's recognition of our funds' consistent performance and disciplined investment approach. These ratings reflect our team's dedication to delivering stable, high-performing investment options across the cash, credit, and fixed-income sectors."  About Mutual Limited   Founded in 2009, Mutual Limited is a proudly independent Australian investment manager specialising in cash, credit, and fixed income.   With a proven track record of performance and trustworthiness, Mutual is committed to serving investors, prudentially supervised entities, and those operating under regulated investment frameworks, providing the stability and expertise that discerning investors seek in today’s dynamic markets. More Information Fund Fact Sheet Mutual Cash Fund Mutual Income Fund Mutual Credit Fund Mutual High Yield Fund For more information or to obtain a copy of the reports, please contact the Copia Distribution Team . DISCLAIMER The rating issued October 2024 - APIR PRM0010AU, October 2024 - APIR PRM8256AU, October 2024 - APIR PRM8798AU, October 2024 - PRM0015AU are published by  Lonsec Research Pty Ltd  ABN 11 151 658 561 AFSL 421 445 (Lonsec). Ratings are general advice only, and have been prepared without taking account of your objectives, financial situation or needs. Consider your personal circumstances, read the product disclosure statement and seek independent financial advice before investing. The rating is not a recommendation to purchase, sell or hold any product. Past performance information is not indicative of future performance. Ratings are subject to change without notice and Lonsec assumes no obligation to update. Lonsec uses objective criteria and receives a fee from the Fund Manager. Visit lonsec.com.au for ratings information and to access the full report. © 2024 Lonsec. All rights reserved.

Scott Rundell sits down to discuss the recent trends with the RBA, Federal Reserve and what the outlook is for the interest rates in Australia and the US.   The topics covered are:   - The Federal Reserve's recent rate cut and its potential impact on the RBA's cash rate.   - Historical comparisons of Fed and RBA policy strategies and how they have aligned or diverged.   - Market dynamics influencing the differences between monetary policy effectiveness in Australia and the US.   - Projections for future interest rates, informed by past trends and current economic data.

Stocks saw little movement following the announcement   Bonds were muted on the statement, but rallied following the press conference   The statement from the RBA remains broadly hawkish, with a focus on core inflation and ignoring false dawns   The next meeting in scheduled for November, but it is not expected to be a ‘live’ meeting The September 2024 RBA Monetary Policy meeting was held yesterday. The board elected to leave policy settings unchanged, which was universally expected. It was a dead rubber meeting, with most attention on the statement and any signs the board has softened its hawkish stance. Yes and no, but on balance still comfortably on the hawkish side of the spectrum. During the post meeting press-conference, Governor Bullock said rate hikes and cuts were not explicitly discussed, rather the structure of the meeting was around what had changed since August. The core message taken from the statement was "while headline inflation will decline for a time, underlying inflation is more indicative of inflation momentum, and it remains too high." This focus on core inflation is a strong message from the board, don’t get sucked in by temporary dips in inflation because of electricity rebates and rent assistance. They’re looking through the near-term noise. The statement also focused more on uncertainties and potential downside than prior meetings, and the “all options are on the table” line has been replaced with “will do what is necessary,” which is arguably less hawkish. Since the last meeting, jobs data has held steady, with over +100K jobs added and a relatively consistent 4.2% unemployment rate, which is tight by historical averages. Wages remain a modest inflationary headwind, but have past their peak. Productivity improvements remain elusive, and back at 2016 levels. GDP printed at its weakest – excluding the covid period – since 1992, growing a very modest +1.0% over the year, better than expected, but still weak. Going forward….“The Board will continue to rely upon the data and the evolving assessment of risks to guide its decisions. In doing so, it will pay close attention to developments in the global economy and financial markets, trends in domestic demand, and the outlook for inflation and the labour market. The Board remains resolute in its determination to return inflation to target and will do what is necessary to achieve that outcome.” Following the post meeting press conference, bond yields plunged 6 – 10 bps and pricing for a December rate cut firmed up. We don’t expect any rate cuts until February next year at the earliest.

The Australian bank regulator, APRA, is proposing to phase out Alternative Tier 1 capital (‘AT1’ or ‘Hybrid’) securities for local banks. As existing AT1 paper reaches its call date, the last being in 2032, banks will be required to replace it with Tier 2 capital. By 2032 bank AT1 securities will cease to exist, which leaves a bit of a hole in retail investors investment universe. In this piece I discuss a couple of viable alternative asset classes to AT1, and a couple of our funds that invest in this space. AT1 securities were an attractive investment for retail investors because of their higher yield vs perceived risk. They generated higher income than term deposits, and generally were less volatile than ordinary equity, and provided a more stable and predictable income stream than dividends. At the height of the covid related market panic major bank AT1 prices fell 20% on average, while major bank shares fell 40% - 50%). Bank bonds on the other hand, both senior and Tier 2, fell only 2% - 3%. Per the announcement last week ( LINK ), APRA has determined that AT1 capital is no longer fit for purpose. In time, as the capital layer is phased out, retail investors will need to find an alternative. Looking at the income and capital characteristics of AT1 securities, two alternatives come to mind. Firstly, Tier 2 securities issued by the banks – which will replace AT1, and then secondly Residential Mortgage-Backed Securities (‘RMBS’), which I’ll touch on in turn below. Both are generally restricted to wholesale investors, so retail investors would need to look at a fund to gain exposure. Two of our funds, the Mutual Credit Fund (‘MCF’) and the Mutual High Yield Fund (‘MHYF’) both hold these securities. Tier 2 capital, or subordinated debt as it is also known, currently ranks senior to AT1 in a bank’s capital stack. Apart from ranking, the main difference is that Tier 2 is a debt instrument, whereas AT1 is a hybrid, with equity characteristics. Tier 2 coupons are contractual, they can’t be deferred, such would be an event of default. AT1 distributions are deferrable without triggering a default. Tier 2 paper is often issued with a ten-year maturity, but with a five-year call option, which to date has always been met by Australian banks. Returns have been historically lower than AT1, but also less volatile as Tier 2 holders benefit from the buffer provided by the AT1. As AT1 is phased out, Tier 2 will effectively assume the ‘buffer’ role of AT1 and as such should be priced accordingly – higher yielding all other things being equal. This re-pricing will likely be a gradual process rather than rapid given the length of the transition period. The schematic below details a simplified bank balance sheet. Liabilities represent the various sources banks use to fund their lending activities, or their assets. Further, to the right we have prevailing spreads for each layer of funding. This is the margin above the bank bill swap rate (‘BBSW’) that determines the coupon paid on these securities. The levels listed here ignore the pricing action seen in recent days as the AT1 spread has tightened as investors scramble to buy what they can before they are phased out. The other alternative is Residential Backed-Mortgage Securities, or RMBS, specifically the mezzanine traches of these structures. In a simplistic sense, a bank’s balance sheet resembles one big RMBS structure. The bank’s assets are loans, predominantly first ranked mortgages, and the funding used to lend against these houses consists of deposits, senior bonds, subordinated bonds, and AT1. The interest on the mortgages is used to pay the interest on the funding sources, with the margin reflecting profitability, which is paid out to equity holders as dividends. For RMBS, the asset side is the same, first mortgages, while on the funding or liability side we have RMBS tranches rated as high as ‘AAA’ (deposit like risk) down to mezzanine tranches rated ‘BBB’ ‘BB’ or ‘B’ (AT1 like risk). As with banks, the interest income from the left side pays the interest expense on the right side. The balance goes to equity – although there are some structural features that prevent dividends being paid to the mortgage originators (banks) until RMBS holders are paid. The schematic below should look similar to the simplified bank balance sheet above. In the bank example, should mortgages begin to fail in sufficient scale, equity and AT1 capital is designed to absorb losses (i.e. a capital loss for holders). Similarly, in an RMBS structure, the same situation would see the equity tranche absorb losses, and then the ‘B’ rate tranche, the ‘BB’ rate tranche and so on. The A$ RMBS market dwarfs both the AT1 market (~$33bn) and the Tier 2 market (~$20bn) in outstanding securities at around ~$200bn. Rated tranches of RMBS structures attract higher spreads compared to equally rated ‘vanilla’ bonds. For example, an ‘AA’ rated RMBS is pricing around BBSW+175 bps, with a maturity of around 3.5 years, compared to say major bank senior paper (‘AA-‘) around BBSW+70 bps. Further down the stack, ‘BBB’ RMBS is at BBSW+200 bps vs BBSW+140 – 150 bps for equally rated vanilla bonds. The extra premium available on RMBS is compensation for perceived complexity risk and liquidity risk, although both are moderating as the market matures. Now, how do retail investors invest? Both are restricted to wholesale investors, so the best way is through a fund, managed by a team of handsome and highly skilled investment professionals with over 100 years of collective experience. And here’s one I prepared earlier. Mutual Limited was established in 2010 and manages $3.5bn across four retail funds and over a dozen wholesale mandates. The firm has a prudent investment philosophy, focusing on bank paper and RMBS / ABS. I’ve personally been investing in RMBS since 1999. Two of our funds are active in the RMBS / ABS space, with a summary of each fund below: The Mutual Credit Fund launched in early 2020, more than doubling in size since launch. The fund invests in senior and subordinated (Tier 2) bonds issued by APRA regulated entities, so banks and insurers, with minimum holding of 60% (currently 70%). The fund can also hold up to 30% in RMBS or ABS securities, with a current holding of 22.2%. The fund is required to be at least 80% invested in investment grade rated paper (currently 90%). MCF returned 8.75% net over the past 12 months.  The Mutual High Yield Fund was established over 5 years ago. The fund has a heavy focus on RMBS / ABS assets, a growth market which has been driven by banks withdrawing from select lending markets, with the void filled by non-bank lenders. The RMBS / ABS market is their prime source of funding. RMBS / ABS allocations are at 42%, down on target of levels of 65% - 75% because the fund has enjoyed strong inflows that are still in the process of being deployed. MHYF returned +11.60% net over the past 12 months.

Late last year APRA announced it was reviewing whether AT1 securities were fit for purpose as effective loss absorbing capital.  A review that was triggered by the collapse of Credit Suisse earlier in 2023, and specifically the treatment of AT1 investors, who were wiped out, while equity investors were left whole. An outcome that contravened the natural order of all things’ regulatory capital.  Recall, Australia is one of the only developed markets where AT1 securities are available to retail investors.  In most similar jurisdictions, AT1 investing (direct) is restricted to wholesale investors. This retail presence in Australian markets represented an area of concern for APRA, specifically whether ADI’s had the intestinal fortitude to use AT1 for loss absorption as per its initial intended purpose should the proverbial hit the fan.   APRA has today announced it is proposing the phasing out of AT1 within bank capital stacks, replacing it mainly with Tier 2 capital (subordinated debt) and a smidge more CET1. The minimum prudential capital requirements remain unchanged, at 13.75%, just the composition has changed - simplified. The proposal is for existing 1.5% AT1 requirement to be replaced by 1.25% Tier 2 and 0.25% CET1 for large banks and all AT1 with Tier 2 for smaller banks.  If implemented as proposed, the changes would be phased in from January 2027 through to 2032, when the last existing AT1 line is due to be called.  Essentially, upcoming AT1 calls will be refinanced with Tier 2 as they roll off.    To maintain an orderly transition, APRA will not expect to approve regulatory calls on these instruments earlier than their documented call dates. Basically, existing AT1 securities will continue to do their thing before eventually rolling off, with the last few lines not due to be call for another 7 years yet. To this end, we note the price of ANZ’s Mar-24 issued AT1, has rallied +0.5% on the day, with traded volumes well below average. Similar for WBC’s Dec-23 issued AT1, up +0.8% on the day, with lower than usual volumes. Over the very near term, we perhaps see a better bid for AT1, but in time they’ll dwindle on the vine, posing longer term threats to hybrid funds and ETFs.   Tier 2 spreads in secondary markets are a smidge wider on the news, a basis point at worst, with minimal traded flows.  The orderly transition process ensures there is plenty of time for banks to replace AT1 with Tier 2 without causing any undue stress on the market’s digestive capabilities. ADI’s have ramped up from just 2.0% Tier 2 to 6.5% as part of APRA’s ALAC requirements over the past five-plus years with spreads currently trading towards the tight end of historical ranges.  Accordingly, I don't expect an additional 1.25% of Tier 2 by 2032 will materially weigh on spreads in the medium term.  In dollar terms the volume of Tier 2 required by 2032 is estimated to be somewhere between $24bn and $26bn, which would see the Tier 2 market grow 20% by the completion of the phase out   APRA did raise the risk of a downgrade to Tier 2 securities from the rating agencies as the loss buffer normally provided by AT1 will disappear, and only been partially replaced by higher CET1. No word yet from the agencies, but this process will be a slow bleed, so I actually doubt any downgrade will be forthcoming. Having said that, if a downgrade eventuated, ratings would be back to where they were six-months ago.   Looking further afield, the move from APRA is positive for Mutual’s funds. More Tier 2 issuance increases the depth of our investment pool, and we would expect to capture some flows out of hybrid ETF’s as the investment universe disappears.  Mutual’s fund invest extensively in bank debt securities, including senior bonds and Tier 2 paper. Following the announcement from APRA, some hybrid investors have talked up the prospect of listed Tier 2 issuance as an alternative for them, but I find this a naïve hope.  APRA’s decision around AT1 is because they don’t want loss absorbing capital in the hands of retail investors.  APRA has alluded to this by saying… “ converting AT1 would impose losses on investors who may not be prepared to absorb those losses, potentially leading to contagion in the broader financial system, further undermining confidence in a crisis.  This is heightened in Australia where retail investors, who are less equipped to absorb losses compared to wholesale investors, participate in the AT1 market. ”  While that references AT1, it’s hard to see how it’s not relevant for Tier 2 also. Source: https://www.apra.gov.au/a-more-effective-capital-framework-for-a-crisis

Earlier today Chris Joye (CIO, Coolabah and AFR journalist) and Andrew Lockhart (MD, Metrics Credit Partners) went head-to-head in a debate on the virtues of public credit vs private credit. Joye has been a vocal and aggressive critic of private credit (because they don’t do it), while Lockhart has built Metrics up as a big player in the private credit space. A transcript of the debate can be found here .    As Joye does, he has already written about the debate and the underlying matter in the AFR ( here ). In said article he claims exit polling had him winning the debate, 69% vs 31%, a poll he ran on his LinkedIn page. A poll conducted by ‘Livewire’, a more impartial pollster had Lockhart win with 55%. You should know my views on private credit by now, but if not, I’ll refresh your memories. I’ve done private credit in the past, didn’t enjoy it. It’s labour intensive and requires specialist skill sets. My main issue with the asset class – here and now – is when it is blended in funds with public credit. Investors need to be mindful of the risks here, specifically around transparency and liquidity. If an investor wants private credit, go to a full private credit fund run by a reputable shop – such as Metrics, they have a strong track record. Don’t invest in a blended fund. And by private credit here, I mean direct lending to businesses that typically are considered too risky for the banks in the post GFC world – in the Australian context, tends to include a lot of property developers. Does this mean I agree with Joye? In some regards, yes – as it relates to the private credit I referenced in the previous paragraph. In others, less so. He’s throwing – at least that’s my interpretation – non-bank originated mortgages into the mix of private credit, which is flawed. Recall, mortgages are used as collateral in RMBS structures. His comments here are twisted. Specifically….   “Looking at all securitised loans (adjusted for biases), we find that non-banks have default rates that are 2.5 times higher than banks . Even if we cherry-pick the very best “prime” non-bank loans, their default rates are 1.5 times worse than the banks . That’s not surprising and reflects the variances in risk preferences between the regulated and unregulated worlds.”  My emphasis. Sound terrible, doesn’t it. But what he doesn’t say is that loss rate on mortgages within banks through time has been 0.02% or 2 bps ($20 for every $100,000 lent). For the non-bank originators, the cumulative loss rate has been anywhere between 0.04% and 0.10% ($40 - $100 per $100,000 lent). Yes, loss rates are higher, but at a base level they’re also very low and have remained so for 30 – 40 plus years.