Pictet doesn't believe in the great rotation

Investors are still buying high-yield and EM sovereign and corporate debt, at the expense of developed-market investment-grade bonds, notes the Swiss fund house.
Pictet doesn't believe in the great rotation

Fund house Pictet argues that certain fixed income investments remain attractive and says it is seeing flows continue into less mainstream and higher-yielding credit and debt. It also stresses the importance of reconsidering one's approach to developed- versus emerging-market debt.

Moreover, certain large asset owners agree that credit investments remain justified from a spread point of view and that the approach to DM and EM debt needs re-analysing.

“We don’t believe in ‘the great rotation’,” says Mickael Benhaim, Geneva-based co-head of global and regional bonds at Pictet Asset Management, referring to the concept that bond returns have fallen to such an extent that investors are set to move wholesale into equities.

Asian institutions are not rolling with the great rotation either, according to a survey by AMP Capital, which notes that after Asian institutions increased allocations to fixed income in the first quarter, the trend will likely continue in the second quarter.

Instead, Switzerland's Pictet sees a rotation from one fixed income asset class into another – say, investment grade into high yield, or high yield into loans.

As a result, the fixed income team has increased its allocation to high yield this year from an already overweight position, and its standard fixed income euro aggregate flagship portfolio has a 10% weighting to high yield, the maximum exposure it is allowed.

Given the correction in US Treasury yields from mid-November to mid-March, the firm generally felt that was an opportunity to increase duration, Benhaim told AsianInvestor during a recent trip to Hong Kong.

Pictet's bond funds in the first quarter saw “significant” flows into standard and particularly short-duration high-yield strategies (more than $500 million) as well as into EM sovereign debt (more than $3 billion), he notes. Investment-grade (IG) funds have been less in demand: outflows of around $500 million in developed-market IG were offset by inflows into EM corporates of the same amount.

Moreover, there have been flows out of hard-currency EM debt products into local-currency EM debt funds – not due to concerns about EM fixed income spreads, but rather because of a perceived threat of US Treasury yield normalisation.

Others, such as the Abu Dhabi Investment Authority (Adia), are not quite as bullish on credit as Pictet, but they agree that a different approach to EM debt is required.

Credit has become a bigger opportunity set in the past few years, notes Paul O’Brien, head of fixed income strategy at the sovereign wealth fund, which has an estimated $700-750 billion in AUM. He notes that, like many other large investors, Adia has in recent years been focusing on a broader range of opportunities in the credit space.

While he argues that “beta is played out in the credit markets”, with yields hovering around 5% for global high yield, he says that yield is perhaps justified from the point of view of spread over, say, sovereign debt. And the current situation won't necessarily reverse any time soon, O'Brien tells AsianInvestor: “You’re still getting spread.”

As for Adia's approach to EM debt, “like most [institutions], we distinguish between global sovereign and global emerging-market debt allocation”, he says. “But I think over time that distinction will erode; people will question whether Malaysia, South Korea etcetera are really much riskier than economies that are labelled as 'developed'."

He points to the growing convergence between sovereign credit ratings, with previously highly rated countries being downgraded and lower-rated ones, such as Indonesia or the Philippines, moving up the scale. Of course, there remains a lot more liquidity in DM than EM government debt, notes O’Brien, “but that is changing as EM issuance is growing”.

“The EM/DM paradigm is becoming less and less applicable,” he notes.

Pictet, too, has been analysing the EM-versus-DM-debt debate. It tends to avoid the traditional split of markets into ‘developed’ and ‘emerging’, preferring to class sovereigns by the quality of their fundamentals, and proposes an approach other than weighting by market capitalisation.

This led to the firm launching a new product in January last year, the Global Bonds Fundamental Fund, which has recently been roadshowing in Asia.

Rather than focusing on, say, GDP weighting – which Pictet sees as backward-looking – the fund focuses on factors such as a country’s capacity for wealth generation and its debt sustainability (looking at currency risk, quality of governance etcetera).

The fund invests in debt issued by 26 countries, of which nine are emerging markets, accounting for around one-third of the portfolio’s weight. This compares to standard market-cap benchmarks, such as Citi’s World Government Bond Index, in which EMs have a 2.6% weighting.

Pictet has won one mandate for the strategy on top of the commingled fund – for $90 million from a Swiss pension fund, which it declined to name – but it has not yet attracted any Asian money. Clients in the region are showing interest, but want to see a longer track record, says Amy Cho, Pictet AM's Asia-Pacific head of business based in Hong Kong.

The commingled fund has $65 million in assets, so has some way to go before it hits capacity, which the firm estimates to be around $5 billion. Pictet is seeing interest from retail and private banks as well as institutions.

The fund is currently available for accredited investors in Singapore and Pictet plans to seek approval to market the fund to retail investors in Hong Kong. It also plans to register the product in Taiwan once it has completed its pending application for three EM debt products.

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