Credit where credit’s due

06/06/2019

Download

​Nick Maroutsos and Daniel Siluk, Portfolio Managers on the Absolute Return Income Strategy, discuss the recent negative sentiment in global credit markets and remind us that not all credit is the same; sometimes it pays to delve more deeply into the reasons behind a particular rating.

There has been a barrage of negative rhetoric around credit markets for some time now. Bad news sells but we believe the balance has been lost in the often-blunt assessments from market observers and participants. Here, we aim to provide more context to the debate, while acknowledging that certain sub-sectors of global credit markets are best avoided. But hasn’t that always been the case? The skill of a good active manager is choosing which stock to be in and which to avoid over time.

What has driven the recent souring of sentiment?
In 2018, the volume of bonds rated BBB increased from around 30% of the US investment grade universe to almost 60%. A worrying trend, yes? Perhaps; but the drivers are clear and unless as an investor you are obliged to blindly track the investment grade index within your portfolio — which our strategy is not — the trend is simple to circumvent. Cheap money (through low rates) made it a better environment to borrow to leverage, often for share buyback or merger and acquisition (M&A) activity. So, a lot of US companies in particular took advantage of this; notably corporates in the commodities, healthcare and telecoms sectors. However, for the risk budget that our strategy permits, we prefer to avoid these instances of financial engineering.
 
BBB as a proportion of US investment grade corporate bonds

 



Source: Bloomberg, ICE BofAML US Investment Grade Index (C0A0), ICE BofAML US Investment Grade BBB (C0A4), as at 31 December 2018.

 
So, should investors avoid the entire BBB space?
Absolutely not. While we do not discount the guide that credit ratings provide us, it pays to delve more deeply into the reasons some issues have such a rating.
 
Areas long favoured by the Absolute Return Income Strategy where there are compelling BBB-rated investment opportunities are infrastructure, utilities and parts of the financial sector. Many issuers in the infrastructure sector are rated BBB, for example Sydney Airport. But these are stable entities with monopolistic features, which can tolerate more leverage in their structures. Other examples include toll roads and ports; and while banks generally have come under greater regulation and rating methodology has become tougher, we think they are certainly no riskier today than before.
 
It is also worth noting that not all BBBs are the same. For example, there is a material difference in credit quality between a BBB+ credit versus a BBB  credit. Currently, the higher quality segment of BBB+ is double the size of the lowest ratings band BBB  in the global corporate bond index. If we do see some downgrades in the investment grade space, naturally the latter segment are likely to suffer the most.
 
Shorten your horizon
A continuing theme in our Absolute Return Income Strategy has been to shorten the average maturity of assets. Typically, we have favoured issues with a 4-7 year maturity where the yield and risk/return intersection has been the most appealing. However, in late 2017, with credit spreads nearing post financial crisis tights, we elected to replace some of those longer dated bonds (in the 4-7 year range) with bonds in the 2-3 year range. Why? Well, if a risk-off event triggers further credit spread underperformance, shorter dated bonds should be less impacted. Further, if no ‘snapback’ rally occurs immediately after the widening episode, the ‘pull to par’ period is far shorter.
But… what if you’re wrong?
There’s always a chance and it certainly pays to keep a hedging card or two up your sleeve in the event that the thesis breaks down. Today, there is a good negative correlation between interest rates and credit risk. That is, if spreads widen, rates will rally. Thus holding some positive duration exposure acts as a positive counterbalance to credit risk. Further, right now, with little chance of hikes in the near to medium term, a long outright duration position adds to the absolute return. It is rare to have periods where you are effectively getting paid carry to hold insurance.
 
So not all doom and gloom then?
No. While there are clear pockets of the credit market smorgasbord that should certainly be given a wide berth, the Absolute Return Income Team maintains its view that you still get well paid to take the risk inherent in a diversified portfolio of investment grade fixed income assets, where the real likelihood of credit default is materially unchanged and arguably more sustainable today, with higher interest rates pushed even further back into the future. However, we believe a sensible approach would be to:
 

- monitor and actively manage the maturity profile — shorter is typically sweeter in uncertain times

- use duration exposure tactically and selectively be more defensively positioned in low beta sectors and high quality credits

- focus on issuers in developed markets, including first tier Asian markets (such as Korea and Singapore).





These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.

Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

The information in this article does not qualify as an investment recommendation.

For promotional purposes.


Important information

Please read the following important information regarding funds related to this article.

Janus Henderson Absolute Return Income Fund

For institutional/ sophisticated investors / accredited investors qualified distributors use only.

All content in this document is for information or general use only and is not specific to any individual client requirements. The information contained in this document is referential and may not be construed as an offer, invitation or recommendation or investment advice, nor should be taken as a basis to take (or stop taking) any decision.

Janus Henderson Capital Funds Plc is a UCITS established under Irish law, with segregated liability between funds. Investors are warned that they should only make their investments based on the most recent Prospectus which contains information about fees, expenses and risks, which is available from all distributors and paying agents, it should be read carefully. An investment in the fund may not be suitable for all investors and is not available to all investors in all jurisdictions; it is not available to US persons.  Past performance is not indicative of future results. The rate of return may vary and the principal value of an investment will fluctuate due to market and foreign exchange movements.  Shares, if redeemed, may be worth more or less than their original cost.

Janus Henderson Group plc and its subsidiaries are not responsible for any unlawful distribution of this document to any third parties, in whole or in part, or for information reconstructed from this document and do not guarantee that the information supplied is accurate, complete, or timely, or make any warranties with regards to the results obtained from its use. As with all investments, there are inherent risks that each individual should address.

The distribution of this document or the information contained in it may be restricted by law and may not be used in any jurisdiction or any circumstances in which its use would be unlawful.

Issued in Europe by Janus Capital International Limited (“JCIL”), authorised and regulated by the U.K. Financial Conduct Authority. Janus Capital International Limited (“JCIL”) is an entity registered and operating under the laws of the United Kingdom and Janus Capital Funds plc. is registered under the legislation of Ireland.

The extract prospectus (edition for Switzerland), the articles of incorporation, the extract annual and semi-annual report, in German, can be obtained free of charge from the representative in Switzerland: First Independent Fund Services Ltd (“FIFS”), Klausstrasse 33, CH-8008 Zurich, Switzerland, tel: +41 44 206 16 40, fax: +41 44 206 16 41, web: http://www.fifs.ch. The Swiss paying agent is: Banque Cantonale de Genève, 17, quai de l’Ile, CH-1204 Geneva. The last share prices can be found on www.fundinfo.com. For Qualified investors, institutional, wholesale client use only. Outside of Switzerland, this document is for professional use only. Not for onward distribution.

This material is strictly private and confidential and may not be reproduced or used for any purpose other than evaluation of a potential investment in Janus Capital International Limited’s products or the procurement of its services by the recipient of this presentation or provided to any person or entity other than the recipient of this presentation.

We may record telephone calls for our mutual protection, to improve customer service and for regulatory record keeping purposes.

Janus Capital Management LLC serves as investment adviser. Janus, Intech and Perkins are registered trademarks of Janus International Holding LLC. © Janus International Holding LLC. For more information or to locate your country’s Janus representative contact information, please visit www.janushenderson.com.

Specific risks

  • This fund is designed to be used only as one component of several in a diversified investment portfolio. Investors should consider carefully the proportion of their portfolio invested into this fund.
  • An issuer of a bond (or money market instrument) may become unable or unwilling to pay interest or repay capital to the Fund. If this happens or the market perceives this may happen, the value of the bond will fall.
  • The Fund may use derivatives towards the aim of achieving its investment objective. This can result in 'leverage', which can magnify an investment outcome and gains or losses to the Fund may be greater than the cost of the derivative. Derivatives also introduce other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
  • If the Fund holds assets in currencies other than the base currency of the Fund or you invest in a share class of a different currency to the Fund (unless 'hedged'), the value of your investment may be impacted by changes in exchange rates.
  • When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise. This risk is generally greater the longer the maturity of a bond investment.
  • Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.

Risk rating

Janus Henderson Absolute Return Income Fund (EUR)

For institutional/ sophisticated investors / accredited investors qualified distributors use only.

All content in this document is for information or general use only and is not specific to any individual client requirements. The information contained in this document is referential and may not be construed as an offer, invitation or recommendation or investment advice, nor should be taken as a basis to take (or stop taking) any decision.

Janus Henderson Capital Funds Plc is a UCITS established under Irish law, with segregated liability between funds. Investors are warned that they should only make their investments based on the most recent Prospectus which contains information about fees, expenses and risks, which is available from all distributors and paying agents, it should be read carefully. An investment in the fund may not be suitable for all investors and is not available to all investors in all jurisdictions; it is not available to US persons.  Past performance is not indicative of future results. The rate of return may vary and the principal value of an investment will fluctuate due to market and foreign exchange movements.  Shares, if redeemed, may be worth more or less than their original cost.

Janus Henderson Group plc and its subsidiaries are not responsible for any unlawful distribution of this document to any third parties, in whole or in part, or for information reconstructed from this document and do not guarantee that the information supplied is accurate, complete, or timely, or make any warranties with regards to the results obtained from its use. As with all investments, there are inherent risks that each individual should address.

The distribution of this document or the information contained in it may be restricted by law and may not be used in any jurisdiction or any circumstances in which its use would be unlawful.

Issued in Europe by Janus Capital International Limited (“JCIL”), authorised and regulated by the U.K. Financial Conduct Authority. Janus Capital International Limited (“JCIL”) is an entity registered and operating under the laws of the United Kingdom and Janus Capital Funds plc. is registered under the legislation of Ireland.

The extract prospectus (edition for Switzerland), the articles of incorporation, the extract annual and semi-annual report, in German, can be obtained free of charge from the representative in Switzerland: First Independent Fund Services Ltd (“FIFS”), Klausstrasse 33, CH-8008 Zurich, Switzerland, tel: +41 44 206 16 40, fax: +41 44 206 16 41, web: http://www.fifs.ch. The Swiss paying agent is: Banque Cantonale de Genève, 17, quai de l’Ile, CH-1204 Geneva. The last share prices can be found on www.fundinfo.com. For Qualified investors, institutional, wholesale client use only. Outside of Switzerland, this document is for professional use only. Not for onward distribution.

This material is strictly private and confidential and may not be reproduced or used for any purpose other than evaluation of a potential investment in Janus Capital International Limited’s products or the procurement of its services by the recipient of this presentation or provided to any person or entity other than the recipient of this presentation.

We may record telephone calls for our mutual protection, to improve customer service and for regulatory record keeping purposes.

Janus Capital Management LLC serves as investment adviser. Janus, Intech and Perkins are registered trademarks of Janus International Holding LLC. © Janus International Holding LLC. For more information or to locate your country’s Janus representative contact information, please visit www.janushenderson.com.

Specific risks

  • An issuer of a bond (or money market instrument) may become unable or unwilling to pay interest or repay capital to the Fund. If this happens or the market perceives this may happen, the value of the bond will fall.
  • The Fund may use derivatives towards the aim of achieving its investment objective. This can result in 'leverage', which can magnify an investment outcome and gains or losses to the Fund may be greater than the cost of the derivative. Derivatives also introduce other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
  • If the Fund holds assets in currencies other than the base currency of the Fund or you invest in a share class of a different currency to the Fund (unless 'hedged'), the value of your investment may be impacted by changes in exchange rates.
  • When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise. This risk is generally greater the longer the maturity of a bond investment.
  • Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.

Risk rating

Share

Important message