Opportunities in global credit investments
Jonathan Harris explains how diversification and themes are powerful tools for credit investors
Diversification and themes are powerful tools for credit investors
The current environment is not an easy one for investors. Looking from the top-down, valuations across risk assets are pricing in a very positive outlook and there is little margin to compensate investors for unpredicted risks. The global synchronised upswing in growth and low default rates provides a favorable backdrop for credit, and while a lot of this is priced in at the aggregate level, there is a lot of scope for active strategies to differentiate between individual issuers to generate outperformance. », points out Jonathan Harris (Investment Director for Schroders).
He expects that the volatility level is likely to remain elevated going forward, with the central banks shifting to a normalization tone in the United Statesand in Europe. « While the European Central Bank is still far away from an hawkish stance, the accent is likely to become less dovish than before. All in all, the financial markets need to find a new normal, which will translate in a more volatile environment. This should also give a more favorable context for active managers going forward ».
At this point in time, Jonathan believes the investors should remain as flexible as possible, and focus on strategies that have the opportunity to invest across markets in order to navigate the risk of rising interest rates in certain regions, in the most liquid parts of the market. « Being unconstrained will help to generate value and income for the investors going forward ».
He also points out that the yearly dispersion of returns between the different fixed income asset classes has been very wide since 1999; and that the bond indexes tend to give very high weightings to the US markets. There are also some opportunities to exploit looking at the political agenda. « Last year, there has been dislocation in France, Italy and the UK caused by elections and referendums, which allowed us to invest at a discount into some quality corporate bonds ».
Use the clock
We have to understand where the potential opportunities are and also where drawdown risks may lie in a highly complex global market. We use our global ‘credit clock’, which we use to track identify where each market is heading in the credit cycle. For example, the deceleration phase is usually the weaker quadrant for some parts of the credit market, when the growth is decelerating and default rates are likely to rise. Larger drawdowns usually happen during the cyclical downturns ».
The clock also shows us that much of the global market is enjoying a synchronised upswing with most regions in the stabilisation and acceleration phase of the cycle, when growth is strong and defaults are low. Markets like Brazil or Russia are showing a positive trajectory, which indicates a positive bias in a global credit strategy. However, it also shows that the UK, having corrected for Brexit fears and economic slowdown, has now discounted a lot of bad news, and « there are now clear investment opportunities in the market. The clock also helped us to position ourselves on Turkey when the market was very low, and a diversification that worked very well for our performance ».
« Some parts of the credit clock can become more sensitive to drawdowns in slower periods. We have divided the credit market in around 100 individual sectors, and we look at the correlations between each of them to identify the strategies that show little correlations between them ». Jonathan also stresses the need to have a very diversified portfolio, and a global strategy that also focuses on security selection provides excellent diversification.
Finally, he also points out that we need to really examine the fundamentals of credit issuers in a forward looking way to select the right issuers and avoid the weakest. To guide this forward-looking credit research, Schroders apply a thematic credit process, which seeks to identify how the world is changing and how companies are managing this change. Themes relate to changing demographics, technology, renewable energy or regulation for example.
« The securities selection will try to be exposed on multiple themes at the same time, and we therefore need to understand the different business models in order to pick the long term winners. The more themes a company is exposed to, the higher the conviction will be. For instance we study how technological disruption is putting pressure on different parts of the markets, and a company like Cap Gemini is going to be exposed on a number of factors (global economic upswing, stronger euro, automation, e-commerce, cyber security) that will give us confidence to be invested in the emissions 1rom this company ».
Important Information: The views and opinions contained herein are those of Jonathan Harris, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.
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