“The most important thing is to understand the collateral underlying the loan,” she says. “We like areas such as residential and commercial mortgage-backed securities because there is greater transparency and it fits our investors’ requirements as they prefer certainty of returns and rather not take on higher degrees of risk.”
ALTERNATIVE SOURCES OF RETURN
Catastrophe bonds, which can generate returns of 4% to 6%, are also creating a buzz. Issuance has been growing at a record pace with around $4.1bn in the first half of 2015, bringing the outstanding total to $21.9bn, according to broker Willis Re.
“They make sense in that they capture different elements of illiquidity, complexity and inefficient pricing,” says Jan Straatman, chief investment officer of Lombard Odier Investment Managers. “They are uncorrelated to other economic risks and capital market events and if interest rates rise, they can offer a hedge as they are floating rate notes and fully collaterised.”
Infrastructure is also on the radar although studies show a clear preference for equity versus debt as well as concerns over the unsuitability of investment structures.
Serkan Bahçeci, head of infrastructure research at JP Morgan Asset Management notes the asset class has lost its lustre. “Today we are looking at 100 basis points (bps) to 130bps over Libor compared to 250- 300bps for project finance bonds,” he adds.
“Overall, the deal flow has slowed but there are certain sectors such as renewables – wind and solar – as well as transportation including seaports and toll roads that have seen an increase in transactions. One of the challenges is although there is a huge need for projects, they are politically-charged and investor expectations have to be managed.”
Tim Humphrey, head of investor solutions at Macquarie Infrastructure Debt Investment Solutions, believes pension funds and insurers like infrastructure debt partly because it provides a match to their longdated liabilities.
“It can offer extra yield and duration compared with corporate bonds and is a good diversification play due to loan defaults being less closely tied to the wider economy. In some cases, investors may also be attracted to the ability to make socially responsible investments. The negative is that these assets are less liquid than corporate bonds and a longer-term horizon is needed, which means that investors with long-dated liabilities are uniquely positioned to utilise their competitive advantage in this space.”
Humphrey notes institutional investors have historically favoured brownfield investments, “however, we do invest in greenfield projects which can also deliver the desired level of credit quality so long as the project builds in appropriate risk mitigation, such as construction guarantees from strong counterparties,” he adds.
Views are also mixed over emerging market debt which has had a challenging time. For example, in August, Deutsche Bank’s aggregate local currency EM bond index suffered its biggest monthly fall this year, taking year-to-date losses to 9%. However, analysts discount fears over a 1997-style credit crisis due to stronger fundamentals. For example, growth in total foreign exchange reserves is almost $3.8trn compared with less than $0.5trn in 1998, according to the International Monetary Fund and Fitch research.
“You can’t discount emerging markets as they account for 50% of GDP and many countries are growing faster than those in the developed world,” says Mike Haylon, managing director of Conning Asset Management. Investors have flirted with illiquid assets for some time now, attracted by the prospect of yield. It it seems now the relationship has moved up a level.
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