…That’s the view of Jeff Boswell, co-Portfolio Manager, Investec Global Total Return Credit Fund as he explains why he believes that these are times for the dexterous master-chef rather than competent cook when it comes to credit investing
The more cautious among us tend to shy away from the lesser-known areas of the investment world. Familiarity brings comfort. And why risk a nasty surprise?
However, in today’s investment environment, a narrow focus on the familiar has arguably become the riskier option. Low and negative interest rates are now a widespread phenomenon. The traditional ‘safe’ areas of the bond market are most exposed to interest rate changes (falling in value as rates rise and vice versa). So, when rates eventually go up, investors with portfolios concentrated in these areas will be particularly susceptible to capital losses.
Fortunately, we think that being more adventurous is entirely compatible with spreading one’s investment risk and building a resilient credit portfolio. With this in mind, we draw on a wide variety of credit markets. Here we explain how combining diversity and dynamism can create a defensive credit portfolio.
Ingredients for a well-diversified credit portfolio
Just as a diet rich in diversity is considered good for one’s physical health, in our experience a similar phenomenon is true in the world of credit investing. Here, more – in terms of the range of credit investments – is a good thing. More sources of yield; more places to look for return; more ways to protect against interest rate changes and to cushion against market wobbles.
A look beyond the more traditional areas of the credit market reveals a smorgasbord of opportunity. In addition to the old favourites such as investment-grade and high-yield corporate bonds – which still have an important role to play in portfolios – investors can find many other instruments. These can both complement and act as substitutes for the traditional favourites. To name just a few:
• Corporate hybrid bonds: these are subordinated debt instruments issued by companies that typically have an investment-grade rating. Corporate hybrids offer similar potential for capital growth as other more traditional bonds but tend to perform better when markets fall. We currently like this subset of the market given its attractive pricing level relative to high-yield market segments, especially given its inherently lower default risk.
• Collateralised Loan Obligations: this type of security results from the packaging up of a diverse pool of corporate loans. Compared with traditional corporate credit investments, CLOs offer various benefits, including historically lower loss rates than corporate bonds with a comparable credit rating. CLOs come in a range of risk tiers, or tranches, making them a useful and flexible tool in the credit investment toolkit – acting as either a complement to or substitute for traditional credit asset classes, depending on the point in the market cycle.
Each credit market subset can react quite distinctively to macro, market and geopolitical events, underlining the potential benefit to be derived from improved portfolio diversification.
Putting it all together
However, what we view as the best option for credit investors today may look very different tomorrow, as shifting market dynamics alter the relative attractiveness of different parts of the credit market. That makes it important to continue to alter our portfolio allocation across the credit market in a timely manner. Dynamism is key.
This means being willing to significantly increase or decrease the allocation to certain areas of the market as market conditions and valuations evolve. This philosophy has seen us hold zero allocations in most areas of the credit market at various points in time, while at other times we have invested as much as 40% of the portfolio in individual core areas of the credit market. This dynamic approach aims to ensure we are always rewarded optimally for the risks that we take, as well as seeking to avoid areas of the market that look over-extended.
Defensive dynamism in action
As an example of this approach in action, tight valuations (and subsequent volatile market conditions) in the second half of 2018 prompted us to position our portfolio away from traditional high-yield markets and into more defensive credit market subsets, where valuations and supply/demand dynamics felt more balanced. The resultant positioning helped us to then preserve investors’ capital through a volatile fourth quarter, with the opportunity to then capitalise on the market’s re-pricing of credit risk. We did this in early 2019 through investing in a variety of different credit markets, including the same high-yield markets we had reduced exposure to six months earlier.
Don’t try this at home
This really is not a case of adding new ingredients into the mix and hoping for the best.
The broad credit market is as complex as it is diverse. A deep understanding of the functioning and intricacies of credit instruments is vital. We think there’s no substitute for experience in how different parts of the credit market behave in different market regimes and at times of crisis – in practice, not just in theory.
Equally important are the skillset, tools and expertise to combine these ingredients together into a portfolio that works for investors at each point in time. Think dexterous master-chef rather than competent cook.
We believe that investors should consider getting more adventurous with credit.
The diversity of the credit market presents us with plenty of opportunities to build a diversified portfolio which aims to be high-yielding yet comparatively defensive. And a dynamic approach allows us to constantly shift to the areas of the credit market that offer the most attractive return potential for a given level of risk.
Underpinned by deep credit expertise, a diverse and dynamic approach can lead to a more consistent return pattern and the ability to participate in a meaningful proportion of credit market upside, while still protecting the downside.
About Jeff Boswell
Jeff joined the industry in 2001 and is Head of Developed Market Credit. He is responsible for managing and leading the Developed Market Credit platform at Investec Asset Management. His responsibilities include acting as a portfolio manager across a range of Investec Asset Management credit funds, including the Multi- Asset Credit funds.
Previously, Jeff worked at Intermediate Capital Group PLC as Head of Portfolio Management within its Credit Fund Management division. He was also a member of the investment committee across both liquid and illiquid Credit Fund Management strategies. Prior to this he was at Investec Bank Limited as Head of Acquisition Finance, where he established the Acquisition Finance platform and led the development of their CLO business. He also held structured and leveraged fi nance roles at NIB Capital (London) and BOE Merchant Bank (South Africa).
Jeff holds a Bachelor of Commerce degree with Honours (cum laude) from University of South Africa, is a Chartered Accountant (SA) and a CFA Charterholder.