Now seems as good a time as any for fixed income investors to try to adapt portfolios more actively, to deal with an environment that has the potential to create ever-greater differentiation in credit risk pricing.
In short, this means investing where there is better risk/return pay-off, backed up by thorough credit analysis.
senior product specialist,
Asian Fixed Income,
HSBC Global Asset Management
“For investors, their choice of security can make great deal of difference to the performance of their portfolios,” says Geoffrey Lunt, senior product specialist for Asian fixed income at HSBC Global Asset Management (HSBC AMG).
In short, a corporate bond that performs badly could mean an investor loses everything. “The role of credit research in this type of active management is integral,” he adds.
SEEING THINGS DIFFERENTLY
From Lunt’s viewpoint, thorough fundamental credit research is the only way to guard against downside risk in terms of avoiding default.
Indeed, proper analysis gives investors a better chance of getting their timing right. While trying to enter and exit at the top and bottom of markets is never a strategy, thorough research can highlight broader trends that portfolio managers can act on.
Especially in the credit landscape, which tends to be less efficient than many other markets, assessing fundamentals often pays dividends.
This is typically seen via those types of business which are better-suited to securing financing. For example, a company that produces consistent cashflow – even if not particularly profitable – will be more successful in debt raising than a company that is much more profitable, but has lumpy cashflows. Further, excessive leverage can create cashflow vulnerability that can cause problems for credit investors.
“This is where investors can add value to their portfolios, through buying bonds with a better-than-average yield and a lower risk of default. Investors who can achieve this will likely outperform,” adds Lunt.
Yet it is a time-consuming process to closely examine a company’s balance sheet as well as broader economic factors impacting that company. As Lunt succinctly puts it: “There are no shortcuts to effective credit analysis.”
FINDING VALUE IN CREDIT
HSBC AMG’s own credit strategy for 2019 is based on combining macro views with bottom-up analysis, supplemented by rigorous credit selection, to try to take advantage of mispricing opportunities.
EM local debt is one of them. The dynamics look good, says Lunt, since yields remain high in many of these places. “We think EM currencies will do well against the US dollar this year given a combination of the US Federal Reserve’s dovish stance plus generally-strong public finances within many EM.”
By contrast, in some parts of the world, especially the US, today’s more challenging stage of the credit cycle means investors are getting paid less for certain risks. Greater headwinds for the global economy plus speculation about whether an inverted yield curve will lead to recession, add to uncertainty, and have taken the gloss off lower-rated high yield bonds.
This has swung Lunt’s attention towards credits in segments likely to be less impacted by rates. This applies to those in the high yield space with higher ratings, and lower-rated (BBB-) investment-grade names. “The market needs to wait for rates to be cut before they may expect further gains,” adds Lunt. “At the same time, if the Fed becomes hawkish, yields might be vulnerable, so cross-over areas look a safer place to be.”
This is where credit research can help remind investors to be careful not to rely on ‘averages’ – in terms of companies that seem well-capitalised and robust amid the backdrop of a relatively low rate landscape.
“Although the average company appears in quite good shape with decent levels of cash and profitability, thorough credit research gives us the ability to identify unhealthy credits even in a healthy market,” says Lunt.
In Asia, those companies that have defaulted over the last couple of years have come from a mixed bag of sectors and countries. One of the common threads, he explains, is where issuance was initially of poorer quality and where identifying severe credit deterioration was possible through credit research.
ADDING AN ESG EDGE
Although thought by some market players as exclusive to equity investing, ESG considerations are also increasingly important to credit research; after all, company behaviour impacts operating cashflows.
Credit investors need to play a greater role in encouraging companies to take action that strengthens their credit profile. “We try to identify ESG-related risks that may result in a company being unable to repay its debt,” explains Lunt.
He sees ESG risks as especially important within certain parts of Asia. “While governance is clearly an area where Asia has improved a lot, there is still a need for many companies to tread carefully from an ESG perspective, such as those in the palm oil industry in Indonesia, and in coal mining in China.”
WIDENING ACCESS TO ASIAN CREDIT
According to Lunt, in their search for performance, investors can generally benefit from the better yields, shorter duration and higher-growth environments associated with increasing their exposure to Asian credit.
Here, too, a rigorous credit research process is essential, given the typically under-researched and less efficient nature of many local markets.
However, the real value-add is the diversification that the asset class can bring to global portfolios. Higher portfolio allocations and weightings to Asia are certainly justified, Lunt adds, given the region’s economic significance and growth trajectory.
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