What should you look for in your credit manager?
What should you look for in your credit manager?
The past decade has been decent to bond investors. With central bank policies driving yields lower, and steady economic growth supporting company revenues, bonds have seen good returns. Here and now though, bond investors are facing some considerable and novel challenges.
Most immediately, there is the ongoing uncertainty of the pandemic. Policy support, including central bank bond purchases, has been vital in restoring stability, and it remains key. The biggest near-term risk is that measures are tapered too soon, while longer-term, the question is whether fiscal stimulus reignites inflation and growth.
Bond yields are unprecedently low, making it harder to generate income or capital returns. It is likely policy support remains in place for some time, keeping yields anchored, but investors could increasingly question this as the recovery takes hold.
Recent events have highlighted the risk of rising yields. With economies reopening and US fiscal stimulus plans, growth and inflation expectations have risen sharply. This has sent bond yields markedly higher, causing significant negative returns for US Treasuries and US investment grade corporate bonds. When yields are low, returns become more sensitive to yield moves.
These risks look set to persist particularly as near-term reflationary pressures continue. Investors need to think carefully about their approach to fixed income. Here are what we see as the key factors.
The diversity and range of global fixed income markets is one thing that can certainly be made to work in bond investors’ favour.
It is difficult to find much value in global investment grade credit currently. Valuations are high overall, but well supported by fundamentals and there is income available from strong companies, and relative value opportunities. Investment grade is more vulnerable to yield spikes, the US more so than Europe.
High yield credit, conversely, can perform well when rates rise, as in recent months, as it benefits more from economic recovery. It offers income and security selection opportunities, while the rise in bonds downgraded from investment grade to high yield, due to the pandemic, is starting to reverse.
Securitised markets offer another set of characteristics and exposures, namely decent income, low default risk, but crucially low duration, so they are relatively cushioned from rising yields.
Yield volatility is likely. This could create opportunities, but there is a lot of capital chasing income. The ability to take advantage of the full range of opportunities across global credit, and to move nimbly, is going to be important.
Active security selection
Despite yields on credit reaching low levels, there are opportunities to generate income and returns if you search hard enough, and in the right places.
The pandemic brought severe dislocations with sectors and companies effectively shut for a period of time. Some of these still offer good recovery potential. Transportation sectors, what we see as “best-in-class” airports or hotel companies being examples, and selective retailers. Names such as Expedia, Ryanair and Heathrow have featured prominently in many of our portfolios.
In high yield, there is an array of niche businesses with distinct individual characteristics. A proportion of the market is unlisted and so less well-researched. This is a rich seam for finding opportunities, sometimes in unusual places.
Similarly, emerging market credit and government bonds offer value, but come with a wide range of often specific risks and characteristics, requiring in-depth research. Asia looks well placed, China particularly, but certain countries are still badly afflicted by Covid-19, others are raising interest rates.
Actively managing duration and mitigating drawdowns
Allocations to securitised and high yield credit can help manage duration risk, but with continued robust inflationary pressure, more active measures may be needed. This could mean positioning directly in sovereign yield curves or hedging duration risk.
It is also important to be mindful of drawdowns. Investors can underestimate how rapidly and strongly correlations occur in moments of panic or stress. We look to analyse and identify where risks could be building up unexpectedly.
Forward-looking focus on long-term themes
Some longer-term themes have been reinforced or brought to the fore by the pandemic. The growth of online consumption looks increasingly entrenched and permanent, but a whole range of online and digital services have become even more central to our lives.
Some themes look set to gather momentum out of necessity. With the COP 26 global climate change summit occurring later this year, the need to reduce carbon intensity in the economy remains paramount and will require substantial investment. We are seeing significant growth in issuance of green, social, sustainable and sustainability-linked bonds.
Real estate remains an appealing sector for corporate bonds. The long-term imbalance between supply and demand, especially in the most desirable “tier one” cities, is a solid underpinning to company fundamentals, particularly in respect of the residential sector. Logistics and data centres also present opportunities.
The unique circumstances of Covid-19, plus low yields and the risk from rising inflation, add up to a generally more challenging world for bond investors. A keen awareness of risks is clearly vital. At the same time, the considerable range within global credit markets affords opportunities for active, flexible and discerning investors to generate attractive returns.
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