A truly active approach to equities based on fundamental research and a disciplined investment process
Most investors agree that, after the strong performance of corporate bonds (also called ‘credit’) in recent years, the environment has become more challenging and we are unlikely to enjoy such stellar returns in future. However, for investors with the resource and motivation to dig deep, global credit still offers plenty of potentially attractive long-term investment opportunities.
Amid trade wars, political uncertainty and rising interest rates, we are entering a much more nuanced environment for credit. Markets are likely to be more volatile, forcing investors to search more widely for returns. We believe flexibility and strong credit selection will be more crucial than ever in delivering solid investment performance.
In this respect, investors who are unconstrained by benchmarks are at an advantage. It means that, instead of worrying about outperforming a particular index or sector, they can focus on achieving positive returns, investing only in those areas that offer the best opportunities.
An investor who is not restricted to one segment of credit – be it investment-grade or high-yield – or to a particular region has infinitely more scope for seeking out positive returns. Areas such as subordinated financials, asset-backed debt, convertible bonds and emerging markets are generally less well understood than traditional areas of credit. As such, with careful research, these markets can offer substantially more scope for finding idiosyncratic investment ideas and mispriced assets. This is particularly useful for navigating periods when traditional credit markets are challenged, and investment returns harder to come by.
Emerging market (EM) credit is one area where, after the recent sell-off in EM assets, valuations have in our view fallen to compelling levels. While the market is likely to remain volatile, for investors with a longer-term investment horizon, there are some potentially exciting and worthwhile opportunities. In countries like Africa, Mexico and Brazil, nascent, fast-growing industries offer the prospect of sustainable, long-term returns. Telecoms, data and property are among the sectors where investors can find well-managed, strongly-positioned firms whose bonds are attractively valued, with above-average yields.
In the US, few would argue that corporate bond valuations are stretched. There are, nevertheless, pricing anomalies and dislocations to be found, particularly among longer-dated bonds. For example, US housebuilders have underperformed in the past year, on worries about the impact of rising interest rates on housing demand. In avoiding the sector, investors have treated all housebuilders as equal, making little differentiation between those businesses that are vulnerable and those that are more securely placed. Closer scrutiny uncovers undervalued bonds issued by financially sound, high-quality companies, operating in desirable locations and experiencing strong, sustainable growth.
In Europe, political uncertainty in Italy is among the factors contributing to the recent turbulence in credit markets. As a result, a number of high-quality corporate bonds have fallen to compelling valuations, for instance in the telecoms and industrials sectors. Financials stocks have been especially hard hit, as investors fretted over banks’ and insurers’ possible exposure to the crisis in Turkey. For long-term investors with a strong research process, such bouts of volatility can present rewarding opportunities.
The importance of rigorous research in selecting the right credits cannot be overstated.
Global trade wars, political uncertainty and worries about rising interest rates will likely temper returns from credit markets in the months ahead. Despite this, there are ample opportunities. We believe investors need to seek diverse and more sophisticated ways to sustain yield levels in their portfolios. At the same time, the importance of rigorous research in selecting the right credits cannot be overstated. Investors with the resources and motivation to dig deeper can uncover undervalued bonds issued by financially sound, high-quality companies with strong and sustainable growth prospects.