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Why Credit Suisse recommends CoCo bonds

Why Credit Suisse recommends CoCo bonds

Karl Ng, lead analyst, Asian fixed income peer group at Credit Suisse Private Banking, Asia Pacific shares his views on finding opportunities in fixed income.

Q. Tell us about your role.

A. I am responsible for the Asian fixed income peer group. My role involves two main aspects:

I. Fund selection: I work with a Singapore-based colleague to select Asian fixed income funds and our selection feeds into the global platform.

II. Fund advisory: I give advice to our bankers, investment consultants and end clients and talk to colleagues who need information on funds.

Q. What are some considerations for you when doing peer group analysis?

A. There are the usual quantitative factors, such as performance, and then some qualitative aspects, such as the experience and  reputation of the managers. We also pay attention to the legal structures and any offering restriction to make sure the subject funds are categorised under the relevant peer groups.

That said, we have to balance this with the size of the peer group in consideration. If there are 20 to 30 funds in the peer group, we can afford to be more granular, but if the peer group only has two or three funds, it does not make sense to break it down into subcategories.

Q. Speaking of legal structures of funds, is there a preference for Ucits funds?

A. We do have more Ucits funds on our platform. I understand that some large international private bank peers tend to steer away from offshore vehicles such as Cayman funds because they may not be distributed in Europe and the onboarding is also operationally more complex. In our case, we do have extra steps in the due diligence process on Cayman vehicles. Therefore, Ucits are preferred. We also see that asset managers are tending towards fund domiciles with more robust regulations.

Q. With fixed income, the main issues now are low yield and high valuations. How are you addressing these in your fund picks?

A. All asset classes are looking more expensive, so it is about picking sectors with relatively attractive valuations. In the fixed income space, we like unconstrained strategies that allow portfolio managers the flexibility to invest in sectors that generate higher risk-adjusted returns, or those that are less crowded by retail demand.

European CoCos and US preferred shares are two areas where our selected managers still see value relative to sectors such as sovereign bonds and emerging markets. On the other hand, the double whammy of compressed yields and increased funding costs have diminished demand for fixed maturity bond products, which gained lots of traction until a few months ago. So the need for product innovation never subsides!

Q. When would you recommend fixed income ETFs over active strategies?

A. In the fixed income space, we generally prefer active strategies because our managers have been able to generate alpha. Furthermore, a substantial amount of flows from our clients are going into unconstrained bond funds, which are not readily available in the passive form.

Also, many bond ETFs tend to be more volatile than active funds, so in the medium term, their risk-adjusted returns may be worse off. We will consider ETFs in sectors where we have tactical research calls on some market betas but do not have a good active solution in place, or where it is difficult for us to onboard one within a short timeframe.

Some recent examples are dollar corporate bond ETFs and an EM local currency bond ETF with top exposures to Latin America and Eastern Europe.

Q. Are there any innovative products that stood out to you this year?

A. In January, we started a campaign to make a push on a fixed maturity US senior loan fund that I thought was a good innovation. Individually, there is nothing new about fixed maturity as a fund feature or senior loans as an asset class, but  combining them into one product will give some investors an easier hurdle to jump – making the less liquid or less well-known fixed income sector more easily accepted by clients who are new to it.

Q. What about CoCo bonds? 

A. We are positive on subordinated financials debt and have been actively recommending these funds since March. One of these funds that we identified has performed very well year-to-date and inflows have been great.

The fund has been on our focus list since Q2 and will likely keep its spot in Q4. Apart from this fund, we have three other fixed income funds with significant AT1 CoCo exposures ranging from 20% to 70%. These funds have been quite well received by private bank clients in the region because of their high carry. Earlier this year, we saw the complete write-down of AT1 CoCo bonds by Banco Popular after the EU authorities declared Popular was ‘failing or likely to fail’ due to an escalating liquidity crisis. However, the write-down has seen no spill-over effect to the broad market. This shows that investors are getting more sophisticated with this asset class, and are therefore able to identify the idiosyncratic risks associated with it.

Q. How has demand for fund-linked structured products been?

A. Interest in this asset class picked up towards the end of last year in the form of protected notes. By their nature, protected  notes need to be built on funds with relatively low volatility in their track records. There are only a handful of funds in the market that will qualify as the underlying investments for these structured products. My guess is that two-thirds of flows into these products go to one or two bigger names.

Q. Word of advice to fund managers?

A. Compared with fund managers, we are generalists. So when it comes to funds, strategies or asset classes that are relatively new to us, managers may need to take time and effort to address our questions adequately. It would be good if managers and their specialists could anticipate possible questions ahead of the meeting and spend more time building the foundations for us before deep-diving into a fund.

The article appeared in Citywire Private Wealth magazine's 2017 Asia Selector supplement.

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