MORE POWER TO YOUR ELBOW
European leveraged loans have been popular as they were largely unaffected by global volatility at the end of 2015 and in the first few weeks of 2016, in stark contrast to US leveraged credit and European high yield bond markets.
“The loans had a difficult credit crisis but they were one of the best performing asset classes last year,” says Annabel Gillard, director within fixed income at M&G Investments.
“There has been a lack of forced sellers and they have proven to be very defensive. We also believe that now is a good entry point for ABS and there is outstanding value after the selloff in the beginning of the year.” Direct lending to mid-sized corporates has also gained momentum, although due diligence is required. “These
strategies offer greater returns and although you forego liquidity, it does not always mean you take on additional risk,” according to Gillard, who says these require closer monitoring and more secure contracts.
She adds: “We do our own in-depth credit research and lend to mid-sized companies where cashflows are stable and predictable.”
Other fixed income investments have divided fund managers such as emerging market debt and contingent convertibles (Cocos). For the former, flexibility is key, according to Andy Tunningley, head of UK strategic clients at Blackrock.
“There is a trade-off betweenlocal debt and hard currency, but what we saw last year is that you have to be fleet of foot and have a dynamic approach that can take advantage of market conditions,” he says. “For example, this year we have rotated into local currency and are picking up double digit returns by being in the right countries.”
As for Cocos, these hybrid securities which are designed to bolster the capital of banks were all the rage until this year when concerns started to mount that the rules for these bonds were too complicated and could undermine a bank’s financial position rather than strengthen it in a crisis.
As Amey says: “Cocos are for investors seeking high returns but who can tolerate volatility. Yields can be around 7-8%, but it is important to maintain exposure to solid institutions, particularly large US and UK banks.”
BIG MONEY
Institutions lacking resources or the inclination to pursue individual or riskier strategies can use multi-asset credit funds combining many of these strategies under one umbrella. They have the ability to generate alpha, diversify assets and mitigate risks. This is why globally these funds have doubled in size over the past three years from £48bn in 2012 to stand at £96bn as of June 30 2015, according to recent figures from Punter Southall.
The risks have also been highlighted. For example, in a credit-stressed environment, high yield, bank loans and ABS may suffer from poor liquidity, plus the defensive tilts and short positions that are taken may only offer partial protection in a selloff.
However, over the long term, fund managers believe these funds should help cushion the blow from such events and produce better risk-adjusted returns for investors.
