Discrimination key for credit investments, says Schroder's Dasher

Karl Dasher, global head of fixed income at Schroder Investment Management, discusses likely developments for Asian currencies and corporate credits in the coming months.

Hailing from Atlanta, Georgia, Karl Dasher has been London-based global head of fixed income at Schroder Investment Management since October 2008. He joined the firm in January last year as head of product and marketing.

He previously worked for SEI, where he started as an analyst in 1994 before heading to South Africa set up the office as country head. From 2000 to 2002, Dasher was the co-managing director and chief investment officer (CIO) of SEI in France, before becoming managing director for continental Europe. In 2004, he moved back to the US to CIO at SEI.

AsianInvestor: What's your current view on the credit markets? Is it still a good time for investors to jump in?

Karl Dasher: The big question is around spread depression -- given how much spreads have already depressed, is it time for investors to be cautious on credit? Should they continue to allocate to credit, should they hold the positions they have? We recently did an analysis of 12 different credit cycles going all the way back to the 1930s, which showed us that there are normal occurrences in terms of when you see compression happen. It is front-end-loaded, meaning 50-60% of the event will happen in the first 12 months; and it always happens in advance of the fundamentals validating it, so it's forward-looking. This is what we've seen occur since March.

What's different about this particular cycle is that the level from which this has started was much higher than most other credit cycles apart from the one in the 1930s, when depression was priced into the market. So investors coming in today are still coming in at levels in many cases where credit cycles normally start, in some cases. For example, if you look at the global high-yield index, we're still talking 800-900 basis points of spread. It's not at 2,000bp, where it was previously, but it's still not that far from where these cycles are normally; still double the average spread you see over a cycle.

So it's still not a bad time for investors to move into credit, if they have the right strategy to attack it. What we are saying to clients is that much of the sell-off was indiscriminate and so was much of the rebound, and going forward the market will become much more discriminate.

We didn't anticipate how quickly the market would come back. We thought that a number of the most distressed issues would not bounce back as quickly as they did, especially when you look at CCC issues in the high-yield universe. We think this warrants further investigation by investors -- are a lot of these distressed securities really going to survive in their current form? At current prices are you going to be paid well for the risk you're taking?

How does Asia fit into the global picture?

We are very bullish on Asia -- it has become the net creditor to the world. If you look at this credit cycle compared to 10 years ago, Asia was the centre of the storm in 1997/1998. And eight years ago, it was telecoms and tech at the centre of the storm. Some people think it's ironic that in today's world those sectors and countries are strong, but it's actually natural, because they have made a lot of required fundamental changes. For example, a lot of tech companies now run high net cash balances, having learned from what they went through in the past decade, and Asian countries have made big structural and are now net creditors to the world.

So we're very positive on sectors and countries like that who've learned and made those changes. They still do not represent for a large percentage of the global corporate benchmark. But they have a large weighting in terms of what we think about the global corporate universe, because a large number of the companies we follow either have significant sales presences, manufacturing presences or risk exposures here [in Asia].

Do you have any comment to make specifically on the outlook for Asian currencies?

Directions of Asian currency moves will be driven more by broad risk appetite and technical factors rather than individual currency fundamentals. Affirming optimistic 'V-shape' recovery expectations are likely to pose challenges ahead, as global and Chinese fiscal stimulus wears off whilst deleveraging and excess capacities undermine final demand globally.

If the above scenario materialises, the dollar may still retain its 'safe haven' characteristics during times of risk aversion. We also expect Asian central banks, with the exception of Indonesia, to continue moderating their currency strength, especially as the yuan spot rate has remained relatively stable.

Looking forward into 2010, we expect to see more trading opportunities within Asian currencies. As the markets continue to normalise, investors will start to look at individual currencies in a more fundamental and localised way. Individual Asian FX themes could emerge in early 2010, as some Asian central banks may consider monetary tightening due to rising inflation expectations and concerns over liquidity-driven domestic asset bubbles.

And how about Asian corporate credit?

In the corporate credit markets, as the global economic recession took hold, corporate credit quality deteriorated such that the rating agencies downgraded numerous ratings. We have also seen a downward trend in credit ratings in Asia. The number of downgrades between Q4 2008 and Q2 2009 was particularly high. The upgrade/downgrade ratio is now more balanced, but the pace of credit improvement will depend on continued economic recovery and improved credit conditions.

Note that corporate profits in Asia have held up reasonably well amidst the challenging operating environment. Unlike in the US and Europe, credit conditions in Asia have been more resilient. This is a function of government stimulus measures and a stronger banking sector.

After significant credit spread tightening since March, with heavy over-subscription of new issues, many credits' absolute yield levels are not far away from their all-time lows experienced during the pre-crisis period of 2006-2007. Similar to the currency markets, spread movement in the near term will be driven by broad risk appetite. However, we see pockets of value in selective segments, such as Asian bank debts and some short-dated high-yield securities. With a busy new issue pipeline expected in the next few months, there are also opportunities to cherry-pick attractively priced issues.

Are you advocating any particular asset types within fixed income?

Within fixed income, we are generally advocating credit, and taking on spread duration within credit -- getting as much exposure to the best quality issues to amplify return on the compression. We are generally underweight interest rate risk exposures due to government bonds and are using spread duration to help offset that. That's generally been the approach we've used across portfolios. We've not advocated an outright short duration by and large, because the yield curve is so steep that a lot of our clients would be leaving a lot of money on the table.

But we are starting to get more interest from clients in pure duration-hedged strategies. That is, taking global corporate portfolios, hedging out interest rate risk back to Libor, taking purely spread on top of Libor -- especially from absolute return-orientated investors. Whereas for pension funds that have the ability to offset duration risk from their liabilities, it seems that a pretty straightforward move into credit is the right thing to do.

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