Schroder ISF EURO Credit Absolute Return
A robust investment process means that the European credit team at Schroders has a strong track record through both bull and bear markets. With market uncertainty currently rising, we talk to Head of Credit, Patrick Vogel, about the newly launched Schroder ISF EURO Credit Absolute Return, which offers investors access to the same investment process with greater flexibility and lower market sensitivity.
Patrick, please can you tell us about Schroder ISF EURO Credit Absolute Return and how it differs from other Schroders EURO credit strategies?
The process we use for core funds like Schroder ISF EURO Corporate Bond and Schroder ISF EURO Credit Conviction has been successful in consistently generating alpha for our clients in a variety of market conditions. The process is designed to generate high levels of alpha, whether in a benchmarked fund or an unconstrained fund, because it allows us to focus on differentiating between issuers where we see opportunity and risks. Schroder ISF EURO Credit Absolute Return uses the same team and process as our core euro credit strategies. The fund will still identify a set of key market themes and then assess the appropriate credit strategy to position the fund around them.
Where this fund differs is that in Schroder ISF EURO Credit Absolute Return, the strategy will aim to accumulate alpha in an absolute return format rather than a benchmark-tied format.
Can you give us a recap on the investment process?
Credit themes are central to our process. Themes can be macroeconomic, consumer, demographic, technological, regulatory etc. but they will all have a strong influence on the business models of companies as they play out. The themes are diversified by type, and by horizon. We identify new themes and review existing themes at a weekly brainstorming meeting, and the results are given to our credit analysts for further research into the companies that are likely to be affected. In parallel, we hold a monthly credit strategy meeting, where we discuss the macroeconomic environment, fundamentals, valuations, systemic risks and the technical backdrop to understand the forces at work behind the market. This helps us assess whether we are taking appropriate risk, and also identify relative value opportunities across markets. In our absolute return strategy, credit themes direct us to the bonds that we buy (or sell) and the strategy meeting helps us to manage the fund’s drawdown risk.
Can you give us an example of one or more of your current investment themes?
Our current themes largely focus on volatility and differentiation within markets and sectors. As an example, one theme relates to the pessimistic angle from which the oil price weakness is being viewed; ignoring the potential upside for areas of the market which could benefit from lower energy costs. Another theme relates to differentiation within emerging markets, which investors are currently inclined to treat as a homogenised block of economies.
How will the fund achieve its aim of generating an absolute return?
As an absolute return strategy, we have more flexibility in where we can invest than a benchmarked fund, and importantly have no exposure to areas of the market we are wary about. Market volatility over the past year has been high. Looking ahead, a high level of uncertainty persists in financial markets, global economic growth, central bank policy, commodity prices and the geopolitical environment, while yields remain low. This leads us to believe that an absolute return strategy which targets a reasonable return with more contained volatility could prove to be very useful. We can, for example, use derivatives to capitalise on dislocations in the values of cash bonds and the implied value of the same issues from credit default swaps (CDS).
The fund will have a long bias, but we will also have the ability to use derivatives to build short exposure in areas at risk, although we do have limits on the levels of credit risk, both long and short. What we envisage is a lower-risk, lower-volatility vehicle that can generate a consistent level of alpha.
What are the risk controls embedded in the portfolio?
As with all of the Schroders credit strategies, the risk management process is embedded throughout the investment process, while each position is monitored carefully. We conduct regular stress tests and there are a range of internal limits to ensure that the fund remains “true to label” and not taking excessive risk.
Schroder ISF EURO Credit Absolute Return will have a minimum exposure of 70% to eurodenominated corporate bonds. There will be a maximum allowable non-euro exposure of 30% (hedged to euro) and there will be a maximum allowable high yield exposure of 30%. However, the focus for risk at Schroders is on being pre-emptive rather than reactive. Our long and successful history of fundamental research has enabled us to avoid some major pitfalls over the past few years.
How do you see the new fund fitting in client portfolios?
We take a pragmatic, thoughtful approach to ensure that Schroders’ clients have access to a sensible suite of strategies that cover the full range of investment needs; applying the same credit investment process. This means that even when client circumstances or objectives change, we will aim to have a suitable strategy available from a team that they know and trust.
Schroder ISF EURO Credit Absolute Return will target three-month Euribor plus 3% over the course of a year, applying the same investment process in an absolute return capacity instead of being benchmark linked. We feel that investors seeking lower risk and a more predictable outcome could use this fund either in its own right or as part of a blend of Schroders strategies that comprise their European credit exposure.
Why do you believe investors should consider the strategy just now?
European credit is one of the few bright spots in the global credit market at the moment. Default rates are low and companies are still managed in a relatively conservative way. Economic prospects in the eurozone also remain positive, particularly in a global context. However, many core euro strategies are forced to own low-yield bonds because of the financial repression of the past eight years. We believe that our high-alpha approach can help to optimise returns.
The additional flexibility of this new fund offers new and existing clients another option to help diversify and insulate their portfolios.