Fundfire (US) - Managers Should Seize Global Credit Opportunities
With interest rates close to the floor in most developed economies, institutional investors looking for performance from their credit portfolios have to work harder and look further. A global credit strategy allows asset managers to take advantage of the ongoing explosion in international debt issuance. They can generate returns for institutional investors by exploiting a wider range of issuers, industries and regions than are typically available in a traditional, domestically focused fixed income mandate.
As corporate debt issuance outside the traditional markets of the U.S. and Europe continues to surge, it is now more useful to look at the asset class through a global, rather than a regional, prism. With the growth of multinational corporations, fewer and fewer large companies can now be fairly described as domestic, and today’s credit markets have evolved to reflect this reality.
Gone are the days of U.S. companies issuing dollar-only debt to the U.S. market or British companies looking only to borrow in sterling from U.K. investors. Increasingly, companies are taking advantage of the ability to issue debt in other markets and currencies. These developments create a number of opportunities for managers to generate performance on behalf of investors.
Comprised of more than one thousand issuers, the global credit market is a large and deeply liquid opportunity set. Investors with a global mandate are able to exploit this wider investible universe and explore opportunities not open to those tied to a rigidly regional mandate. Most obviously, an investor has significantly more companies in which to invest. This allows them to seek out quality companies regardless of where they operate and in what currency they choose to issue their bonds. The increasing tendency for larger companies to issue bonds in more than one currency can also be an attractive source of performance. It is not uncommon for anomalies to arise between the trajectories of bonds issued by the same company but in a different denomination. Effectively exploiting these cross-currency opportunities can generate additional returns for the same level of credit risk.
Similar advantages flow from having increased flexibility at a sector level. A cautious European-based manager may, for instance, be somewhat wary of the eurozone’s still fragile banking system. A global mandate enables them to take more of their banking sector exposure through U.S. banks, many of which have significantly improved their balance sheets in recent years.
While the U.S. remains by far the largest credit market, around 35% of outstanding bonds came from other regions as of May 2013, according to our firm’s research. This geographic spread gives managers, consultants and investors the scope to focus on specific countries, regions or economic blocks, depending on where they see the best value.
A prominent example is the higher-growth economies of Latin America and Asia. There has been a huge increase in issuance from these areas in recent years. In the 12 months leading up to April 2013 alone, the market grew by close to 30%, according to Bank of America.
Companies like Petrobras and Vale are now regular issuers of debt to international investors. Much of this debt comes with a higher yield than issuance from developed markets, reflecting a perceived increase in credit risk. This perception that Latin American and Asian debt is riskier is not always justified.
Emerging market economies are proving more resilient than those in the developed world, and their companies are generally in good financial health. Moreover, issuers in these markets are often under-researched, allowing an experienced bond manager with sound credit analysis skills to unearth hidden value. While emerging markets remain a small part of the overall credit universe, successfully exploiting this segment of the market can add meaningful performance for clients.
Going hand-in-hand with access to a wider investible universe is greater diversification and exposure to countries at different stages of the economic cycle and markets with their own particular dynamics. Global credit markets are strongly correlated, but discrepancies do arise between them for reasons of economic variability, liquidity constraints or local pension/insurance fund flows.
For instance, 2009 and 2010 saw massive divergence in performance between the major credit markets. Active bond managers with leeway to invest across regional markets are able to exploit these differences, an opportunity not open to those tied to a narrowly regional mandate. Moreover, a truly global exposure would have provided a smoother return during the intense volatility of those years, as shown by the chart below.
The benefits of a global approach to credit investment are clear. Managers with the flexibility to explore global opportunities and make allocations outside the confines of a regional benchmark give themselves the opportunity to gain valuable performance, widen their investment universe and, at the same time, further diversify clients’ portfolios to manage their level of risk.
Erlend Lochen is the head of U.S. credit and global high-yield at Standard Life Investments
First published in Fundfire on 20th September 2013