Navigating corporate bonds as the wind changes
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The UK hit the headlines recently after the Bank of England became the latest central bank to hike interest rates. In a widely expected move, the Monetary Policy Committee (MPC) voted unanimously to raise rates to 0.75% at its August meeting.
With the US already well underway in terms of raising interest rates, and even the Bank of Japan muting it may reassess its monetary policy, Jonathan Harris, investment director, fixed income at Schroders, says we are now clearly in a period where central bank policies are at the forefront of investors’ minds.
However, while he admits this will have an impact on bonds generally, from an individual security and issuer selection point of view, he says there remain plenty of opportunities to generate alpha in credit.
“With uncertainties surrounding Brexit, the potential for a trade war between the US and China and weaker market confidence towards emerging markets, periodic volatility in global markets looks set to remain a feature for the time being,” he says.
“We said at the end of last year that the low volatility we had been treated to previously would not be sustainable, and indeed, more volatility is needed to breathe fresh life and value into markets to support future returns.”
In such conditions, Harris maintains it is key that credit managers look further than just whether the credit markets as a whole are rising or falling, but really focus in on what is happening within the markets.
“There is always the opportunity to identify and capture alpha, you just need to have the approach and the resources to do it,” he says. “In credit, we emphasise security selection, because within the market there is a very complex and diverse ecosystem as the issuers themselves are operating in a highly competitive global market place, where some will thrive and some will struggle.”
Take the UK for example. Given the headwinds that Brexit has created, Harris says he would be surprised if the Bank of England would be able to take a more aggressive stance going forward, all else being equal. Brexit will present challenges, but there will certainly be many companies that will survive, “comfortably” meet their liabilities and their bonds perform well.
“Our credit investment themes, which include Brexit, provide our investment and research team with a forward looking context to judge the adaptability and resilience of corporate business models, and ultimately identify value and risk,” Harris explains.
“Put another way; we look to understand how the world is changing and how corporate issuers are able to adapt to that change, and this drives our security selection,” he says.
“It is an approach that is highly adaptable. Whether we are in a bull or a bear market, some issuers will perform better than others. So whatever Brexit scenario takes place, there will be bonds that show value and those you want to avoid.
“The ability to differentiate between these issuers is an extremely good source of alpha potential, which can compound over time and drive strong relative returns in your portfolio. It is an approach which has the potential to generate performance in bull or bear market conditions.”
Cycle not over
So where does Harris believe we are in the credit cycle at this juncture, and where does the Schroders team see the best opportunities within it?
“Globally, the US is benefitting from more accommodative fiscal policy which is helping to extend the cycle there,” he says. “In Europe while momentum seems to have slowed after a very strong run of data, it seems to have settled at around trend levels, so we remain quite positive on credit fundamentals overall.”
One area in particular Harris identifies as looking relatively attractive at present is investment grade credit in Europe.
He explains: “Many investors had been quite overweight in European credit, which was reflected in valuations at the end of 2017. However since the end of last year – with the rise in volatility, changing central bank policy, concerns over emerging markets and other things – investment grade credit spreads widened quite significantly, as the market re-evaluated how much risk it should be pricing in.”
“As a result we think that the opportunity set is opening up again.”
Staying ahead of the market
In terms of its offering, Schroders manages over 20 different credit strategies, which Harris says can help investors navigate the ever-evolving marketplace, but also help our clients to achieve specific investment objectives. For example, some of its funds offer less interest rate sensitivity, while others can provide more global flexibility or income.
“As the market evolves, it is important an investment manager has a diverse fund range and discusses with clients their objectives and the options available to navigate market conditions,” he says. “It is also important for us to understand the challenges our clients face and look to innovate to address them.”
“Research is also critical, especially really in-depth research. If we focus our efforts on where the potential value lies, dig deeper and build high conviction the rewards can be very compelling.”
Jonathan Harris is Investment Director and Strategic Capability Manager for Credit at Schroders
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