Fixed Income Boutique

Hunting from on high

Viewpoint

The world of investing is full of animal analogies. Market directions are referred to in terms of “bulls” and “bears”, central bankers are known as “doves” or “hawks”, investors who follow the herd are “sheep”, and those who ignore what’s going on around them are “ostriches”. Even the famous economist John Maynard Keynes wrote about “animal spirits” to describe the emotions that affect consumer confidence.

So, following on in this rich tradition, let’s look at the animal that best represents a global corporate bond approach: the golden eagle. The global corporate bond category is broad and one of the largest asset classes, just as the golden eagle is one of the most widely distributed and largest species of eagle. In fact, it is the most common national animal in the world, with countries as diverse as Mexico, Germany and Kazakhstan honoring it as their national symbol.

The search for investment targets is also similar to how an eagle hunts: viewing the landscape from on high and spotting opportunities that others on the ground would miss, then diving in with focus to scoop up the quarry.

 

Evading the downside…

A global approach provides multiple benefits to investors, allowing them to choose from a large opportunity set, ranging from developed markets to emerging markets, or from investment grade to high yield, just to name a few dimensions (see Chart 1). All these pillars can generate returns, but become even more powerful with the right mix in one portfolio.

2018-10-29_mp_fi_gmy_chart1


One advantage comes from the risk management perspective: bond managers with regional mandates are exposed to local shocks, which appear regularly; such as Brexit, the Italian budget crisis, or the turmoil in Turkey. The impact of these events in a global portfolio are usually less severe, making your investment more robust.

This is exactly what we aim for: a well-diversified portfolio not biased to a specific region or segment.

In addition, we like to invest in the most liquid bonds, which makes it easier to pick up potential new positions, reduce holdings quickly when negative factors hit a certain region or rating class, and to exit profitable trades. The global credit universe tends to be very liquid as individual bond securities are often larger in size, helping when trading actively and offering relatively low bid-offer spreads. For example, bonds issued by Anheuser-Busch, the global leader in the beverage sector, are extremely liquid, with bonds outstanding of 11 billion US dollars in size (just for one bond).

This added liquidity and broader diversification provides the opportunity for investors to limit the downside. In order to measure this ability, investors often use the “downside capture”1, which should ideally be below 100% (see Table 1).

… and capturing the upside

With a global approach, in addition to “limiting the downside”, you will be able to increase your upside potential: depending on where we are in the prevailing economic or credit cycle for any given area or rating. You could benefit from improving global trends by shifting your regional or sector allocation quickly when needed. This makes it possible to opportunistically pick the market segments which are most appealing. For example:  

  1. In the energy sector we currently favor the US over Europe, where this segment is small and without convincing credit stories.
  2. In the banking sector, we favor the subordinated bonds from European banks, as they offer more choice and spreads look more compelling, even though US banks are fundamentally stronger than ever.

This ability, of being unconstrained by a specific market, segment, or region is the recipe to construct a portfolio with more upside potential. To judge if a portfolio manager is able to benefit from this upside potential, investors often use the “upside capture”2, which should ideally be above 100% (see Table 1).

Seizing on market inefficiencies through relative value…

While investment-grade corporate bond markets are mostly efficient, multiple drivers within these prior mentioned market segments offer opportunities for active managers to generate alpha. These market inefficiencies arise as many investors still think in limited categories or specific sub-asset classes. They are not able to look across their own fenced in area and seek more profitable trades that can be found from the same issuer, simply by purchasing their bonds in another market. We take advantage of these investor inabilities by identifying and analyzing bonds rigorously and most importantly across regions. Let’s take a look at a specific example from the above mentioned Anheuser Busch, which issues bonds in multiple currencies due to their global activities in quenching the thirsts of beer drinkers across the world. With the help of our proprietary tools, we compare these bonds one by one and are able to spot bonds that offer superior spreads in one currency over the other, with the currency exposure always hedged. For example, in chart 2 below, you can see that on several occasions in 2016 the Anheuser Busch bond in US dollar offered over 200 basis points additional spread without compromising on rating, duration or liquidity.

2018-10-29_mp_fi_gmy_chart2

Taking advantage of such a “risk-free” spread pickup is a powerful advantage that only a global portfolio can achieve.

… and profiting from rating moves

Investors can exploit similar inefficiencies by comparing senior unsecured bonds versus subordinated bonds, or by taking a closer look at the BBB and BB-rating universe. Here, Sharpe-ratios are the highest of all rating categories, because of those investors forced to stick to their narrow investment baskets (such as bonds with an investment-grade rating only, for example). However, it’s these mispricings that usually occur in cases of a downgrade to the high-yield segment. Once we put a bond through our thorough credit analysis process we can take advantage of these inefficiencies. The same works in the other direction, namely to search for “rising stars” (upgrade candidates from BB to BBB) in order to benefit from the spread tightening before the crowd will invest into this particular bond. As we have a global and broad investment team, we can make use of our internal resources such as in high-yield credit, emerging market credit or simply the fact that we are also well connected to the largest of all markets the US with our fixed income analysts in New York. Our setup and the examples above combine to serve one goal: exploiting market inefficiencies actively and investing where we see value.

We provide investors access to the above mentioned strategies through our Vontobel Fund - Global Corporate Bond Mid Yield. You could call it a “best-of-credit-collection“, and we are convinced that a global approach is the best way for investors to get involved into the corporate bond market. As chart 3 below shows, many investors are already realizing this potential and allocating globally:

2018-10-29_mp_fi_gmy_chart3


Whereas growth in large, traditional credit categories is slowing down, for global corporate bond funds the growth trajectory has been impressive, with a compounded annual growth rate (CAGR) of almost 40% in the last ten years.

Spotting the opportunities

To sum up, our fund invests in a wide opportunity set that makes it possible for us to create a robust portfolio with the ability to perform better in both up and down markets (see table 1). Unlike regional investors, we are able to spot opportunities from on high and grab them from wherever they may be. Therefore, as we reach the three-year anniversary of the fund, we encourage investors to take flight from their traditional investment categories, expand their horizons, and join us in the hunt for returns.

2018-10-29_mp_fi_gmy_table1
2018-10-29_mp_fi_gmy_chart4
 

1. Downside capture is calculated by taking the fund’s monthly return for the periods, during which the benchmark had a negative return and dividing it by the benchmark’s monthly return for the same time periods. The lower the result, the better.
2. Upside capture is calculated by taking the fund’s monthly return for the periods, during which the benchmark had a positive return and dividing it by the benchmark’s monthly return for the same time periods. The higher the result, the better.
3. Up/downside capture ratio is calculated by dividing the upside capture percentage by the downside capture percentage. A result of above one shows that the fund has outperformed its benchmark during periods of up/down markets.