Fixed Income Boutique
“Are we there yet?” every parent on a road trip with kids will have heard these words coming from the back seat. It used to be an irritant, but now, after a year of travel restrictions it’s a fond memory and something we all yearn to hear again.
Right at the top of the list of things we all want to do, when the lockdowns are lifted and it’s safe to do so, is to travel. While it’s a poor substitute for the real thing, we’re going to take you on a virtual journey, stopping off at scenic spots across the globe, which we also see as rich pickings for corporate bond investors. So buckle up and we promise you’ll arrive before you can say “are we there yet?”
Taking off from Zurich, our home base, our first destination is towards the land of the free and the home of the brave, big old USA. Just like the skyscrapers of New York, the US dollar market offers the highest yields amongst developed market credit. In addition, like the wide plains of the Mojave Desert, the market is broad, with many well-known and established companies.
Everything is bigger in the US, steaks, cars and, for bond investors, issue size, which tends to be larger than in other markets and many issuers have bonds outstanding in multiple currencies – a land of opportunity for active investors to benefit from “spread optimization”, allowing investors to benefit from the best yielding currency in developed markets (while taking into account hedging costs). On top of all this, the US economy is recovering strongly, which should help to repair the credit metrics of companies easily.
In the US, we benefit from our New York-based colleagues, such as analysts Jim Stahl and Pam Gelles as local travel guides. Pam likes the US telecom and media landscape, which remained solvent by offering great movies and entertainment programs during the pandemic. From a credit analyst point of view, we like the de-leveraging path of these companies, re-affirmed after spending about 90 billion US dollars for the new US spectrum auction1.We also like the US banks, and when visiting Manhattan, where many are based, the Oyster Bar & Restaurant in New York’s Grand Central Station is a handy choice for lunch, offering great food and a roof worth seeing. Due to their strong earnings generation capacity throughout the pandemic and a solid capital base, most of the time, we view the US banks as “less-stress investments”. The capital structure of a bank offers multiple ways to invest. We like to compare senior versus subordinated bonds, and have a clear preference for senior, as the subordinated bonds appear expensive to us.
For subordinates, it’s back to Europe where we find more opportunities in subordinates with their diversified bank universe, including AT1 securities. But before that, from the US we head to South East Asia.
Let’s continue our journey to the hustle and bustle of South-East Asia, where our Hong Kong-based analyst colleagues Cosmo Zhang and Pius Xue are the local experts. With an average growth rate of 20% p.a. over the last ten years, the Asian investment-grade market is the fastest growing corporate bond market in the world, and now issues five times more investment-grade bonds than Latin America. South-East Asia’s variety of countries and cultures, the presence of large investment-grade-rated sovereigns, and strong economic growth, gives the region good roots to flourish like a cherry orchard. Chinese state-owned enterprises (SOEs) for instance, constitute a good opportunity to invest in emerging industries, while benefitting from the solid high-single-A rating uplift of China with an attractive yield level. Ideal for investors who are looking for income.
Then it’s off to India, the world’s largest democracy, and an auto rickshaw drive around Mumbai. Asia is an interesting area when it comes to the de-carbonization efforts of the utility sector, making it ideal for ESG-minded investors. It’s a little-known fact that India is a new hotspot for renewable energy investors as it targets to reach 40% of non-fossil fuel installed power capacity by 2030 (from 10% in 2019). The debt issuance in its renewable-energy sector is booming, and often comes with a high level of securitization and a green label. Therefore, it represents an outstanding opportunity to invest in carbon-neutrality while boosting the carry of the portfolio. Going forward, you’ll be hearing a lot more about India and green investing.
Then it’s time to head on back to Europe where an investor can get broad country and sector diversification. Here, the economic recovery is lagging a bit but as central bank support remains strong, we are screening for more cyclical sectors, which will rebound faster as daily life begins to normalize, such as capital goods and transportation. Europe is great for scenery, so many people prefer to travel by train or car, making toll road operators in Spain or Portugal an interesting pick for when Northern Europeans are able to travel south again.
Europe is also the home of the corporate hybrid market – an asset class that is not as popular in the US. The market segment in Europe is growing at a rapid pace and is now about 170 billion euros in size as corporate hybrids allow companies to bolster their credit rating. For corporate hybrids, we stop over in the Italian capital, Rome. The ancient Romans were known for their public utility services, for example, building aqueducts that supplied their cities with clean water. Now, in 2021, we still like Roman utilities, but with a more modern angle: the electricity and gas supplier Enel, a solid utility company with stable cash flows. Of course, when in Rome, do as the Romans… and if you’re brave enough, do as Gregory Peck and Audrey Hepburn and rent a Vespa, a great way to see the city and enjoy your own Roman holiday. Last but not least, the market segment of Additional Tier 1 (AT1) securities is a great destination for yield seekers. The segment requires more preparation work before jumping in, such as understanding the bond documentation e.g. the Maximum Distributable Amount (MDA2) but is rewarding with an attractive yield pick-up and the shorter call dates tend to be less rate sensitive.
This year, 2021, has been the worst start for fixed income, including corporate bonds, in terms of total returns. Our investors know that we do not actively manage duration in our strategy, as our focus is on credit selection, but we acknowledge that inflation expectations did run quite far, we would even argue a bit too far. We believe that the higher yields have positive implications for investors:
Therefore, from a risk-reward perspective, the case for global corporate bonds looks much more compelling now than at the end of last year. These higher yield levels, in particular at the longer end of the curve start to attract buyers, such as insurance companies and pension funds with a more long-term view on the market. This buying interest is supported by very moderate FX hedging costs as the yield difference of US dollar bonds versus the rest of the developed world increased. We observed Japanese and European investors already allocating towards global credit in order to benefit from this opportunity. Seems like these investors also, like us, prefer to “travel” virtually to the most interesting spots around the globe to find value.
So there we are, a whistle-stop tour across the globe. We hope you enjoyed our travel guide and encourage you to reach out to us for further insight on our most popular “travel destinations”.
1. A spectrum auction is where a government sells the rights to transmit signals over specific bands of the
to assign scarce spectrum resources. In the US, this means large US Telecom companies, such as AT&T or Verizon need to bid for the licenses that can be used to build out faster and more powerful 5G networks.
2. Three metrics are key for AT1 investors:
a. Maximum distributable amount cushion (difference between bank`s capital ratio and its maximum distributable amount),
b. Distance to trigger (difference of a bank’s CET1 ratio and the contractual write-down/conversion trigger), and
c. Available distributable items, which need to be sufficient to pay AT1 coupons.