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Gaining the edge in global credit: time to think like equity managers

Gaining the edge in global credit: time to think like equity managers

The scenery is shifting for global credit fund managers.

Performance over the last few years for many fixed interest portfolios has all been down to embracing the most lucrative themes and getting the asset allocation right.

Such approaches have worked very well but many prominent fund managers no longer believe they can rely on such strategies.

For Citywire A-rated Euan McNeil, manager of the Kames Investment Grade Global Bond fund, the coming year will be largely about making the correct stock selection calls.

‘For the last couple of years stock selection has been important but by far the biggest driver has been your position from a risk perspective, such as going overweight credit,’ he says.

‘We’ve had roughly 40% of our portfolio in global financials which has been a positive driver as regulators are trying to make banks safer.’

However, McNeil, who is ranked 11th among his peers over three years (see table below) reckons it’s time to change tack. He doesn’t believe it’s possible to continue making money by positioning portfolios for one or two quarters with a lot of credit risk and then rotating based on volatility.

‘It’s about constantly questioning and rotating positions that we think will become important to differentiate our portfolios from rivals.’ – Euan McNeil, Kames

‘If you accept you’re not going to get that generic volatility then the argument is you look for other sources and ways of making money,’ he says. ‘That’s why we think a stock-specific approach is going to become increasingly important.’

What he looks for in a potential holding depends on the nature of its industry and a lot hinges on how a company compares with other names in the same sector and whether that is likely to change in the coming months.

‘It’s trying to be proactive in altering the portfolio when we think something becomes fully valued or the spread relationship between two names has played out as we had expected,’ says McNeil. ‘It’s all about rotating it and buying the company that has lagged.’

A potentially disastrous move, meanwhile, is leaving the portfolio alone for long periods. ‘It’s about constantly questioning and rotating positions that we think will become important to differentiate our portfolios from rivals.’

Top corporate bond managers by manager ratio over five years

Manager Rating TR % USD Manager Ratio Contributing Fund
Adriaan Stoffelen A 159.87 1.44 Sydinvest Virksomhedsobligationer HY, Sydinvest Virksomhedsobligationer HY Akkumulerende
Mark Kiesel A 53.95 0.99 PIMCO GIS Global Invt Grade Credit Inst USD Inc
Klaus Blaabjerg 117.17 0.73 Sparinvest-Corporate Value Bonds EUR R, Sparinvest-Investment Grade Value Bonds EUR R
Lisbeth Albér A 57.74 0.72 Danske Invest Globale Virksomhedsobligationer
Thomas Kristiansson 59.49 0.26 SEB Corporate Bond EUR C (EUR), SEB Corporate Bond SEK C (SEK)
Eric Janca + 41.51 0.03 HCM Bond Select R A
Daniel Berg 74.21 0.00 DNB Global Credit
Alberto Foà + 29.90 -0.05 AcomeA Obbligazionario Corporate A1
Marco Sozzi + 29.90 -0.05 AcomeA Obbligazionario Corporate A1
Tugrul Kolad 28.96 -0.16 Pioneer Funds Austria - Corporate Trend Invest T

Citywire Manager Ratio: Manager Ratio reflects how much ‘added value’ in terms of outperformance against the benchmark the fund manager delivers for each unit of risk assumed, where risk is defined as not mirroring the index’s return. It ties together the fund manager’s personal career history with the Information Ratio of the underlying funds.

Going for growth

A-rated Mark Kiesel, who is ranked second over five years (see table above) at the helm of the PIMCO GIS Global Investment Grade Credit fund, says his preferred current strategy is to own growth companies because they have the most financial flexibility.

‘We want those that can pay down debt the fastest as they will be upgraded and see their spreads tighten,’ he says. ‘We also like to own companies with strong fundamentals and the most upside in terms of enterprise value expansion.’

In recent times he has been very overweight the US energy revolution and points out that some of these names are growing five times faster than the overall economy. ‘We own E&P companies like Continental Resources and long-haul pipeline firms, as well as smaller companies such as MarkWest Energy.’

'You have to know where the growth is coming from and if it’s sustainable, and you need to understand whether the company is going to reward the shareholder or bondholder' – Mark Kiesel, PIMCO

Another favoured area continues to be housing and building materials, on the basis that building permits have been growing at more than 20% a year over the last couple of years. This is a fact that Kiesel believes has escaped detection.

‘This industry is growing rapidly so we’ve been owning homebuilders, building materials companies and home improvement companies,’ he says. ‘One of our top ideas is USG, which is basically wall board, as well as appliance manufacturer Whirlpool.’

It’s a theme that’s likely to remain in the portfolio for the foreseeable future. ‘Not only are more homes going to get built but due to house price increases more homeowners are in a positive equity position and want to spend money on remodelling,’ he says.

Turning to Europe, he has recently become more positive on the peripheral countries, which has resulted in increased exposure to Spain and Italy.

‘We also have been invested in autos and auto parts throughout Europe as we think this industry has bottomed and you will see consolidation,’ he says. ‘We also like cable throughout Europe as it’s a very asset rich industry and the need for internet and broadbrand will drive pricing.’

Looking more internationally, the biggest overseas opportunity he’s involved in is the Macau gaming revolution. ‘This market is growing at 15-20% so we’ve been invested in groups such as Las Vegas Sands and Wynn Resorts,’ he says. ‘These companies all have licences in Macau, which is a US$40 billion market, seven times the size of Las Vegas.’

To run a corporate bond portfolio successfully you need to think like an equity investor, he says, which involves buying companies with the best fundamentals as they’ll be more able to organically repair their balance sheets.

‘It’s a function of understanding two elements,’ he says. ‘You have to know where the growth is coming from and if it’s sustainable, and you need to understand whether the company is going to reward the shareholder or bondholder.’

Top corporate bond managers by manager ratio over three years

Name Rating TR % USD MR Contributing Fund
Louis Chabrier AA 20.78 0.73 Skandia Global Foretagsobligationsfond
Mark Poole AA 24.65 0.69 BlueBay Structured Fd Glo Div Corp Bd Base H EUR, BlueBay Structured Fd Glo Div Corp Bd Base H GBP
Klaus Blaabjerg 32.32 0.53 Sparinvest-Corporate Value Bonds EUR R, Sparinvest-Investment Grade Value Bonds EUR R
Søren Stilling Christensen AA 18.39 0.52 Storebrand Global Kreditt IG
Dimitri Andraos 27.18 0.48 Swiss Life Funds (LUX) Bd Gl Corporates R EUR
Adriaan Stoffelen A 28.44 0.47 Sydinvest Virksomhedsobligationer HY, Sydinvest Virksomhedsobligationer HY Akkumulerende
Lisbeth Albér A 23.96 0.45 Danske Invest Globale Virksomhedsobligationer
Daniel Berg 16.62 0.37 DNB Global Credit
Mark Kiesel A 17.71 0.36 PIMCO GIS Global Invt Grade Credit Inst USD Inc
Raphael Muller A 19.75 0.25 Hermes Global Investment Grade Z GBP Acc
Euan McNeil A 22.56 0.25 Kames Investment Grade Global Bond A Inc GBP Hdged

Citywire Manager Ratio: Manager Ratio reflects how much ‘added value’ in terms of outperformance against the benchmark the fund manager delivers for each unit of risk assumed, where risk is defined as not mirroring the index’s return. It ties together the fund manager’s personal career history with the Information Ratio of the underlying funds.

Digging deeper

Citywire A-rated Adriaan Stoffelen, manager of the Sydinvest Virksomhedsobligationer fund, who is ranked first within the sector over five years, believes the key to his fund’s success has been getting a broader understanding of the investment by checking the books, finding out if the numbers add up and asking questions such as: is the investment cheaper than its peers in the market and what could go wrong with the issue?

‘The outperformance of 2012 and 2013 and the beginning of 2014 was driven by our sector allocation, but more importantly, the security selection in our fund,’ he says. ‘We have managed to find the right papers.’

'We are willing to accept volatility if we see a committed shareholder behind the company' – Adriaan Stoffelen, Sydinvest

As far as individual companies are concerned, Stoffelen needs to be comfortable with their standard data, such as operating numbers, cash flow and balance sheet. ‘In some cases, potential support from shareholders can change the balance in our valuation,’ he says. ‘We are very serious on ethics and do not invest in companies crossing ethical lines.’

Recently, the fund has enjoyed success in the telecoms and energy sectors with Stoffelen highlighting Corral Petroleum Holding, a Swedish refinery, as one of his favoured names.

‘We are willing to accept volatility if we see a committed shareholder behind the company,’ he says. ‘In the same category falls Siemens Telecom, where less than perfect numbers are sugarcoated by potential shareholder support. This provides us with the comfort to hold the bonds.’

Currently he likes the emerging markets with a short duration, but is careful with China and sectors like media. On a positive note he still likes both banking and the consumer non-cyclical areas.

‘We also like the Nigerian oil company Afren, maturity 2020 with a 6.5% yield in dollars, as well as a Dutch fruit and vegetable company called Univeg, maturity 2020 with a 7.6% yield in euros,’ he says.

Selective financials

For Klaus Blaabjerg, who ranks third over both three and five years, it’s been the financials sector that has driven performance, together with small-cap energy names.

Conversely, basic materials – iron ore and nickel producers – contributed negatively to his Sparinvest Corporate Value Bonds fund.

‘For 2014 we still look towards financials to find the good performance,’ he says. ‘Lloyds and RBS have been strong credit stories and are still developing nicely in terms of progress. We have cut exposure a little but still see them as core holdings.’

On the insurance side he has a position in French company Groupama, as he believes it has benefited from tough decisions.

‘It had a really difficult 2011 but made some necessary moves and seems to be on the right path now,’ he says. ‘It’s a good credit story where you repair yourself, and focus on factors such as debt reduction to make yourself a more secure investment.’

Although more focused on individual bonds than anything else, Blaabjerg has recently added to Mafrig, a Brazilian meat producer, partly due to currency views.

‘We believe the Brazilian real will weaken substantially in comparison to the US dollar,’ he says. ‘This company has its cost base in Brazilian real but its revenue in dollars so when the dollar is strengthening against the real its margins will look better.’

He agrees the situation within credit markets has changed. ‘You don’t have a ton of undervalued bonds anymore and the market is definitely more fair in terms of pricing,’ he acknowledges.

‘In some situations it might even be expensive but if you’re willing to step away from benchmarks you can still find bonds that are undervalued.’

Predictions

So what does the future hold? Blaabjerg accepts that rising interest and inflation rates could be an issue but believes the biggest risk to credit markets is a hard landing in China following years of ‘too rapid’ credit growth.

Inflation rates, Blaabjerg suggests, will be fairly moderate over the coming years although safeguards are in place within his portfolio. ‘We use floating rate notes to mitigate the risk of rising rates – just in case,’ he says.

Generally, however, he expects 2014 to be a ‘carry friendly’ year for credit, featuring better growth in developed markets with inflation remaining low.

Kiesel at PIMCO believes the biggest concern is aggressive tapering by the Fed – due to either a pick-up in growth or inflation – as this would create a lot more volatility in the market.

‘The change in central bank support for the financial markets is a big deal and probably one of the biggest risks for markets going forward.’

This article originally appeared in the February issue of Citywire Global magazine

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