CC-BY-SA-2.0, FlickrPhoto: Brian Jeffery Beggerly. High Yield in the Crosshairs
Investing in high yield bonds is not for the faint of heart. That said, the risks associated with below-investment-grade bonds are frequently overstated and couched in hyperbole, believes David P. Cole, CFA, Fixed Income Portfolio Manager at MFS.
Late last year, investors beat a thunderous exit from high yield bonds, which in turn reverberated through financial markets as analysts pondered the implication of deteriorating credit markets on the US economy. More recently, investors have made a U-turn, and high yield has witnessed inflows again and spreads have tightened. Talk of a US recession has similarly subsided.
According to the expert, high yield bonds are subject to a cyclicality that mirrors the economic cycle — and default risk is an important factor in total investment returns. If one understands the cyclical backdrop of the high yield asset class and adopts an investment approach that involves prudent security selection, particularly in the lower-credit-quality segment of the market, high yield bonds can make a compelling addition to a well-diversified portfolio.
“The asset class has historically delivered a risk-return profile somewhere between higher-quality fixed income and equities, and has exhibited characteristics of both markets over full market cycles. In the period from 1988 to 2015, the Barclays U.S. High Yield Corporate Bond Index delivered a compounded annualized total return of 8.1% — more than the 6.6% return of the Barclays U.S. Aggregate Bond Index but less than the 10.3% return of the S&P 500 Index”, points out.
High yield bonds can offer diversification against interest rate and equity risk. With relatively low interest-rate sensitivity compared with other fixed income asset classes, the US high-yield market may offer a buffer against a rise in interest rates.
Prudent security selection in the lower-quality segment
Volatility in the lowest-rated high yield bonds can be significant. For this reason, it’s important to focus on differentiation in return and risk characteristics by credit quality, as the returns of the lower-quality segment of the market can vary quite meaningful from that of the overall high yield market.
Historically, highlights Cole, investors have not been adequately compensated for a strategic allocation to lower-quality segments of the high yield market, as the perceived carry advantage is often offset by capital losses due to defaults. Compared to the higher-quality portions of the high yield market, the lowest-rated high yield securities (CCCs) have produced lower compounded returns given the variance drain — losses incurred from heightened volatility because of the wealth erosion caused by downdrafts in security prices — associated with their significantly higher return volatility.
“While lower compounded returns argue against a strategic overweight to CCCs, this market segment also displays a greater dispersion of returns than those in the higher-rated BB or B portions of the market. This suggests potential opportunities to add value by selectively investing in CCC securities, especially on the heels of a significant selloff, when credit spreads have widened substantially”, explains the MFS portfolio manager.
Consequently, says Cole, a tactical allocation to the lower-quality segment of the high yield market can be appropriate when one is being sufficiently compensated for taking on the additional price risk. In the current environment, for instance, energy and mining companies may become attractive. However, investments in these lower-rated securities must be carefully weighed against the overall risk profile of the portfolio, as they can be both distressed and highly illiquid.
“December’s headline-driven selloff in high yield, prompted by a small handful of high yield strategies that ran into trouble with overweight positions in commodity sectors and CCC-rated securities, provided a stark reminder of just how important it is to manage credit risk in high yield”, concludes.
For MFS, the high yield market provides an opportunity for investors to gain exposure to the credit market with an asset class that provides diversification and an attractive return profile over time. Investing in this market also requires prudence, an eye for identifying inflection points, and favoring certain names — such as those on the higher-quality tier of the credit quality spectrum — to deliver attractive risk-adjusted returns.
Glen Finegan. Emerging Markets Equities: Positioning And Opportunities in Henderson's View
Glen Finegan, Head of Emerging Market Equities at Henderson, provides a detailed update on his strategy covering recent market drivers, performance and activity, and his outlook for the asset class.
How have the emerging markets performed so far this year?
A sharp decline for the MSCI Emerging Markets Index in January was followed by a strong rally during February and March, leading to a gain for the asset class overall during the first quarter of 2016.
Against this backdrop the Henderson Emerging Markets Strategy, outperformed a rising market. The investment in gold producer Newcrest Mining and significant exposure to companies listed in the unpopular Brazilian, Polish and South African markets helped. The strategy’s Egyptian and Nigerian holdings performed poorly and fell during the quarter. Over the last year the strategy declined less than the benchmark. Our approach of owning high-quality companies with properly aligned controlling shareholders and strong track records of delivery aided relative performance.
What can you tell us about your portofolio allocation?
We added to the strategy’s Brazilian positions during January’s market fall only to reduce these somewhat towards the end of the quarter following a rapid increase in valuation. We are confident the strategy owns high-quality businesses with strong franchises that will enjoy cyclical recovery when it comes. Predicting the timing of this is, however, impossible, meaning we remain extremely valuation sensitive.
Emerging consumption ¿Cómo ha funcionado el tema del consumo en los mercados emergentes?
We fully disposed of the strategy’s SABMiller position during the first quarter. The discount to Anheuser-Busch InBev (ABI)’s takeover offer has narrowed considerably and the deal still has to clear a number of regulatory hurdles. In the unlikely event it should fail there would be substantial downside in this stock.
Our search for high-quality, reasonably-valued consumer companies in India resulted in the purchase of a new holding in leading cement producer Ultratech.
Cement consumption in some less developed markets shares the same fundamental driver as basic fast moving consumer goods, namely improving living standards. Indian cement sales are conducted mostly in cash and demand is largely driven by the need for improved housing. Housing in India is primarily financed by savings and construction is often as wholesome as adding a small room to an existing property. More than 90% of cement sold in India still comes in bags rather than in bulk, indicative of this being a consumer-driven market. Furthermore, per capita consumption of cement remains low, meaning there is scope for this to increase over time.
What is Ultratech’s appeal?
A unique feature of Ultratech is its network of over 50,000 dealers throughout India selling “Ultratech” branded cement. This network is far larger than any of its competitors and has enabled the company to reach an almost 40% market share in rural India.
Ultratech is one of the crown jewels in the Aditya Birla Group, accounting for approximately 10% of group revenues. Aditya Birla is a family-controlled industrial group led by Kumar Mangalam Birla. Since becoming Chairman in 2004, after the passing of his father, Kumar has shown an ability to take a long-term approach to building strong franchises in a number of industries, including cement. He is also recognised as a leading advocate for strong corporate governance in India.
With the backing of the Birla family, we believe Ultratech will continue to take a leading role in the consolidation of India’s fragmented and overly-indebted cement industry.
What about China?
We have continued building a position in Fuyao Glass following a meeting with its Chief Financial Officer. Fuyao is China’s leading auto glass manufacturer and serves well-known carmakers in China and now also in the US and Europe. The company is a governance leader in China thanks to its far-sighted controlling shareholder who has insisted on global auditing standards since listing in 1993 and emphasised research and development investments to protect the long-term profitability of the franchise. We find the company’s current valuation undemanding given its opportunities for growth.
What is your strategy going forward?
Weak rule of law combined with many undesirable political and business leaders mean there are parts of the emerging markets universe that are cheap for a reason. We are not deep value investors and aim to avoid being seduced by low-quality companies trading cheaply. Neither are we outright growth investors and we continue to avoid what we believe are overvalued but growing South Asian consumer businesses. Instead, as bottom-up stock pickers our focus is on combing unpopular markets for good-quality companies trading at reasonable valuations.
CC-BY-SA-2.0, FlickrPhoto: Moyan Brenn. Schroders Enters into Market for SME Direct Lending Through a Partnership with NEOS Business Finance
Schroders today announces that it has entered into a strategic relationship with Dutch direct lending firm NEOS Business Finance. Schroders has acquired a 25 per cent. stake in the business.
Launched in 2012, NEOS Business Finance provides institutional investors access to an alternative debt financing platform for Dutch small and medium-sized enterprises (SMEs). The company has developed an approach to give SMEs access to small to medium size loans through a standardised issuance and loan terms process.
NEOS Business Finance will provide investment advisory services to Schroders in connection with the management of investment funds of Schroders’ clients investing in SME financing.
NEOS Business Finance has an extensive network and broad client base. To date, NEOS Business Finance has launched one investment fund funded by two large Dutch pension funds. In addition NEOS Business Finance works with the largest Dutch bank ABN Amro to source SMEs in need of financing. This complements Dutch government policy which encourages pension funds and other institutions to actively participate in local economies.
Philippe Lespinard Co-Head of Fixed Income at Schroders said: “Small and medium enterprises (SMEs) in Europe are increasingly looking to obtain debt financing from non-bank lenders. Part of this trend is explained by the decreasing supply of credit in that space by commercial banks who face increasingly onerous capital requirements on loans perceived as risky by regulators and supervisors. On the demand side, borrowers expect faster approval times and lower collateral requirements than afforded by banks’ traditional processes and systems. These conflicting trends open up a space for non-bank actors to provide growth financing to SMEs on simpler and faster terms.”
CC-BY-SA-2.0, FlickrPhoto: Susanne Nilsson. Repurchasing Confidence: The Potential Benefits Of Stock Buybacks
There’s no substitute for a well-run company with solid fundamentals, steady earnings growth and a seasoned management team. But investors in even the most profitable firms are always looking to add value. Two commonly used methods for bolstering corporate shareholder value are dividends and stock buybacks.
A company may decide to repurchase outstanding stock for many reasons — to telegraph confidence in the company’s financial future, return cash to investors in a tax-efficient manner (shareholders typically pay taxes on dividends) or simply to reduce the number of shares outstanding. In some cases, buying back shares just makes good financial sense – particularly when a company’s stock is trading at a discount, explains Thomas Boccellari, Fixed Income Product Strategist at Invesco.
A positive buyback performance track record
For these same reasons, investors may wish to consider companies with a propensity for repurchasing shares. A company stock repurchase is like reinvesting a dividend without incurring taxes.
“Consider also that the shares of companies that repurchase stock have tended to outperform and exhibit lower volatility than the broader market. In fact, studies show that buyback announcements have historically led to a 3% jump in stock price on average, and that the subsequent average buy-and-hold return over four years was 12%” points out the strategist.
And he adds, “the chart below shows the dollar amount of share buybacks for companies within the S&P 500 Index since 2004, as well as the performance of the NASDAQ US BuyBack Achievers Index relative to the S&P 500 Index. A rising orange line indicates that the NASDAQ US BuyBack Achievers Index (BuyBack Index) outperformed the S&P 500 Index; when the orange line is falling, the BuyBack Index underperformed the S&P 500 Index”.
So, according to the expert, while past performance is not a guarantee of future results, you can see that when the dollar amount of buybacks increased, as shown by the purple line, the stock of companies that repurchased shares (as measured by the BuyBack Index) generally outperformed the S&P 500 Index. Conversely, when the dollar amount of buybacks decreased, the stock of companies that bought back shares generally underperformed the broader market.
The benefits of international buyback shares
While stock buybacks have long been popular as a means of returning cash to shareholders in the US, they are also gaining favor internationally — particularly in Japan and Canada, poins out.
“Investing in international companies with a history of buying back outstanding shares offers the added advantage of international exposure — including geographic diversification and, in some cases, more attractive valuations than US-based companies. With both interest rates and stock valuations currently low, I believe international companies will increasingly view share repurchases as a sound investment proposition and a means of enhancing shareholder value”, concludes.
The PowerShares International BuyBack Achievers Portfolio tracks the NASDAQ International BuyBack Achievers Index and provides diversified exposure to international companies that repurchase their own shares.
CC-BY-SA-2.0, FlickrPhoto: Scott Hudson. Risk Budget: Spend It Wisely
“Inflation is when you pay fifteen dollars for the ten-dollar haircut you used to get for five dollars when you had hair” – Sam Ewing (baseball player)
According to Aneet Chachra and Steve Cain from Henderson, discussing inflation far too often devolves into a cage match between the “deflation forever” team versus the “hyper-inflation is coming” camp. The former has gained the upper hand with ECB President Mario Draghi pushing through a comprehensive easing package while Google searches for “helicopter money” are surging. However, based on recent economic data and the stabilization in commodities, a moderate pickup in inflation is more likely ahead. Meanwhile, the US Treasury Inflation-Protected Securities (TIPS) market appears to systematically underestimate future inflation due to structural reasons. Thus, bond markets and the Federal Reserve could be “behind the curve” necessitating two or more rate hikes in 2016 with a knock-on effect on medium-term yields. This is not a call for persistent, surging inflation, but rather a view that fixed income markets are overly optimistic in disregarding the risks of higher inflation.
February headline consumer price inflation (CPI) in the US was just +1.0% year-over-year (YoY), however core CPI (which excludes food & energy) rose +2.3% YoY, its highest reading since 2008. This wide differential was mainly due to lower commodity prices, especially crude oil which fell -32% YoY through February 2016. However, the March 2016 decline is much smaller at -20% YoY, and the futures curve projects that oil’s year-over-year change will turn positive during the fourth quarter of 2016.
Another deflationary force has been the rising US dollar which gained 20% over the last two years, reducing the cost of imported goods. But the year-over-year change for the dollar index just turned negative for the first time since mid-2014. This will gradually make imports more expensive for US consumers, although with a typical lag of 6-12 months.
Importantly, lower unemployment is finally driving higher wages with companies passing on some of the post-crisis profit margin expansion to employees. Fourteen US states have raised their minimum wage in 2016, with California (the most populous state) poised to further increase its minimum from $10/hour to $15/hour over the next five years. Labour markets have recovered not just in the US and the UK, but the unemployment rate in Japan is below pre-crisis levels. European unemployment remains elevated but has been improving since 2013.
Given all the above factors are widely known – why do TIPS still only forecast annual inflation of about 1.6% over the next decade? Perhaps TIPS prices are biased. There is an argument that TIPS should be expensive relative to nominal bonds as they are one of the few ways to directly hedge inflation risk.
But the available evidence since TIPS were launched in 1997 shows the exact opposite. Even with fairly benign inflation over the last 20 years, realized 5-year and 10-year inflation has averaged above TIPS-implied forecasts at issuance. The average gap has been about 0.35% per year ie. TIPS buyers have generally outperformed nominal bondholders.
Despite their valuable inflation protection qualities, why have TIPS historically been under-priced? Two reasons stand out. The first is their liquidity is poor relative to regular US bonds – traders joke the acronym really stands for “Totally Illiquid Pieces of Stuff”. Secondly, inflation expectations are often highly correlated to equity market moves particularly during large sell-offs. Hence TIPS do not provide the diversification to risk portfolios that other bonds do.
The generally negative correlation of nominal treasuries offer significant hedging benefits and are likely expensive to reflect this “crisis alpha” value – especially in the era of Risk Parity funds. Thus nominal treasuries are overvalued, TIPS are undervalued, and both distortions artificially compress the implied inflation rate forecast. An alternative measure that uses nominal 10-year yields minus trailing 12-month core CPI shows that real US 10-year rates are currently near 30-year lows of -0.5% per annum.
An interesting historical precedent is the 1985-1988 period when oil prices collapsed from above $30/barrel in late 1985 to below $10/barrel in 1986 pushing inflation lower. However, starting in 1987 (see black line below) a gradual rebound in oil prices drove a spike in CPI. This led to several Fed rate hikes and a significant selloff in US treasuries, with bond yields rising from 7% to above 9% within six months.
“Although we are unlikely to see a bond selloff quite as severe as 1987 given sluggish world growth and low yields globally, fixed income markets appear to be ruling out even a modest spike in rates. We should also not underestimate the highly stimulatory effects of cheap energy on importing nations where offsetting shale oil industries do not overwhelm them – eg. the Eurozone and Japan. Remarkably, Fed funds futures are only pricing in one rate hike this year, while US 10-year yields have fallen about 30bps in the last five months despite a concurrent 40bps rise in core CPI. Stronger inflation data and consequently a rise in bond yields appear to be an underappreciated risk,” they conclude.
Source: Bloomberg, as at 30 March for all data, unless otherwise stated.
CC-BY-SA-2.0, FlickrPhoto: Koshy Koshy. The Reserve Bank of India is Focusing on Liquidity and Transmission
In his latest white paper, Paul Milon, Investment Specialist, Indian Equities, Hong Kong at BNP Paribas Investment Partners talks about the Reserve Bank of India’s decition to cut its key policy repo rate by 25bp to 6.50% on 5 April 2016. in what he believes was a widely expected move.
“The 25bp repo rate cut was widely expected by financial markets. By January 2016, Consumer Price Index (CPI) had met the central bank’s target of 6% and now seems on track to be at 5% by March 2017. Moreover, the budget announced on 29 February supported the government’s commitment to fiscal consolidation. Despite the pressure on expenditure from the implementation of the 7th central pay commission, the budget maintained the government’s fiscal reduction targets aiming for a deficit of 3.5% of GDP for FY2017, down from 3.9% for FY2016.”
He mentions that as well as the rate cut, the RBI has also taken several steps to improve liquidity and transmission. “While the cash reserve ratio (CRR) was unchanged, the minimum daily CRR was reduced from 95% to 90%. Additionally, the Marginal Standing Facility (MSF) rate was reduced by 75bp to 7% and the reverse repo rate was increased by 25bp to 6%, leading to a narrowing of the policy rate corridor from +/-1% to +/-50bp around the repo rate.
These measures to improve liquidity, combined with the recent introduction of the marginal cost of funds-based lending rate (MCLR) on 1 April 2016, are likely to lead to better monetary transmission. Since the implementation of the MCLR, fresh lending rates have already declined by around 25bp and are expected to decline further following April 11th’s measures.
Following this rate cut, the RBI is likely to remain cautiously accommodative. In assessing further moves, the RBI will monitor a) the CPI inflation trajectory along with the 5% target by March 2017; b) monsoon development as deficient rainfalls could lead to higher food inflation; c) the inflationary impact of the roll-out of the 7th pay commission; and d) evidence of transmission of prior policy rate cuts into lower lending and deposit rates.
In light of the inflation dynamics and RBI’s targeting of 1.5%-2% positive real rates, there may be room for another 25bp rate cut later this year, pending sufficient monsoons occurring.
Following the rate cut, banks are expected to lower their deposit rates, which may lead to more domestic investors shifting part of their assets from deposits to equities, providing some support to the Indian equity market.
He concludes that “More broadly, the accommodative monetary policy stance – with a focus on improving liquidity and policy transmission – is expected to help India’s economic recovery, especially as lower lending rates should lead to a pick-up in credit growth. The RBI continues to expect India to grow at 7.6% as measured by Gross Value Added (GVA) for the financial year ending in March 2017 (FY 2017), the fastest growth rate among large economies.”
Amundi continues to develop its ETF, Indexing and Smart Beta, which are major components of the Group’s strategy. In this context, Fannie Wurtz is appointed Managing Director of the ETF, Indexing and Smart Beta business line under the supervision of Valérie Baudson, member of Amundi’s Executive Committee.
Fannie Wurtz is Managing Director of ETF & Indexing Sales at Amundi. Prior to joining Amundi in February 2012, she was responsible for ETF Institutional Sales and Amundi ETF business development with French & Swiss institutional clients at CA Cheuvreux from 2008.
In addition, the Board of Directors of CPR Asset Management has appointed Amundi’s Valerie Baudson as CEO of the company. CPR Asset Management is a subsidiary of Amundi which manages, in particular, thematic equities with close to €38bn in assets under management.
The CPR Asset Management Board of Directors has also promoted Emmanuelle Court and Arnaud Faller, respectively, to Deputy CEO heading business development and Deputy CEO heading investments. Nadine Lamotte has been confirmed as Chief Operating Officer responsible for Administration and Finance. The above named make up the Management Committee which also includes Gilles Cutaya, Head of Marketing and Communication.
CC-BY-SA-2.0, FlickrPhoto: Jason Kotik, senior investment manager, North American Equities at Aberdeen Asset Management . Jason Kotik will talk US Small Caps at the Fund Selector Summit in Miami
Jason Kotik, senior investment manager, North American Equities at Aberdeen Asset Management is set to discuss smaller companies investing when he takes part in the upcoming Fund Selector Summit Miami 2016 on the 28th and 29th of April.
As a manager, Aberdeen has been harnessing big ideas in the North American smaller company space for years. The companies may be small, but they believe they have the potential to pack a punch for long-term investors, especially those willing to dig deep.
The conference, aimed at leading funds selectors and investors from the US-Offshore business, will be held at the Ritz-Carlton Key Biscayne. The event-a joint venture between Open Door Media, owner of InvestmentEurope, and Fund Society- will provide an opportunity to hear the view of several managers on the current state of the industry.
Kotik, Aberdeen senior investment manager and member of Aberdeen’s North American Equity Team, will speak about how to find such opportunities, including reasons why the current period offers opportunity to invest in small-cap equities.
Kotik’s responisbilities include co-management of client portfolios at Aberdeen, which he joined in 2007 following the acquisition of Nationwide Financial Services. Previously, he worked at Allied Investment Advisors and T. Rowe Price. He graduated from the University of Delaware and earned an MBA from Johns Hopkins University. He is a CFA charterholder.
You can find all the information about the Fund Selector Miami Summit 2016, aimed at leading fund selectors and investors from the US-Offshore business, through this link.
Photo: DanNguyen, Flickr, Creative Commons. Nordea Asset Management Expands its Active U.S. Fixed Income Offering with U.S Core Plus Bond Fund
Nordea Asset Management (NAM) announces that it has launched on April 4, 2016 the Nordea 1 – US Core Plus Bond Fund, provides investors active, diversified investment across the different sectors of the U.S. bond market. The investment objective of the Fund is to maximise total return over a full market cycle through income generation and price appreciation.
DoubleLine Capital LP (DoubleLine) is the sub-manager of the Fund. With this new offering, NAM broadens its partnership with DoubleLine, which as the sub-manager has provided investment services to the Nordea 1 – US Total Return Fund since its launch in 2012.
While the core of the portfolio consists of Investment-Grade U.S. debt instruments (covered by the Barclays Capital U.S. Aggregate Index), the “Plus” in the Fund name indicates that the investment universe expands beyond the traditional benchmark sectors to areas such as High Yield, USD-denominated Emerging Market Debt and non-Agency mortgage-backed securities.
“The design and flexibility of the Fund allows it to take advantage of areas of the market which DoubleLine believes offer attractive risk-adjusted return opportunities,” says Christophe Girondel, Global Head of Institutional and Wholesale Distribution. “We believe that the Fund forms an important addition to our current range of U.S. Fixed Income solutions, one of the major asset classes in any well diversified portfolio,” he adds.
The launch fully leverages Nordea’s multi-boutique approach and capabilities. This new fund complements the existing U.S. Fixed Income range of the Luxembourg-domiciled Nordea 1 SICAV, currently comprising a Low Duration US High Yield Bond fund, a US Corporate Bond fund, a US High Yield Bond fund, a North American High Yield Bond fund and a US Total Return Bond fund.
DoubleLine is an independent, employee-owned money management firm based in Los Angeles, California, U.S.A. Led by Chief Executive Officer and Chief Investment Officer Jeffrey Gundlach, the firm is widely recognised for its expertise and strong track record in active fixed income management. DoubleLine has been managing a similar strategy to the Nordea 1-US Core Plus Bond Fund since 2010.
DoubleLine’s investment philosophy is to build portfolios designed to outperform under a range of market scenarios by shunning away from unidirectional bets. The Fund achieves this through top-down active management of exposure to specific market segments combined with bottom-up security selection.
CC-BY-SA-2.0, FlickrPhoto: Matthias Born, senior portfolio manager, European Equities at Allianz Global Investors. Allianz GI’s Matthias Born is attending the Fund Selector Summit
Matthias Born, senior portfolio manager, European Equities at Allianz Global Investors will be discussing structural growth investing at the upcoming Fund Selector Summit Miami 2016, taking place 28-29 April.
Born, who is lead portfolio manager on the Allianz Europe Equity Growth Select fund, will outline how a high conviction strategy can focus on the most attractive structural growth ideas. His fund has been designed to benefit from bottom-up stock selection, through which weights on individual stocks are based on conviction levels across growth, quality and valuation criteria.
The conference, aimed at leading funds selectors and investors from the US-Offshore business, will be held at the Ritz-Carlton Key Biscayne. The event-a joint venture between Open Door Media, owner of InvestmentEurope, and Fund Society- will provide an opportunity to hear the view of several managers on the current state of the industry.
Born was appointed co-leader of the Investment Style Team Growth in 2009. Since then he has been lead portfolio manager of the funds and mandates of the strategy Euroland Equity Growth and Continental Europe Growth.
Before joining Allianz GI he worked for the Middle Market Group (Global Corporate Finance) at Dresdner Bank. In 2001, he graduated in Business Administration from the University of Würzburg with a master’s degree.
You can find all the information about the Fund Selector Miami Summit 2016, aimed at leading fund selectors and investors from the US-Offshore business, through this link.
