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Financial markets are pricing in corporate credit default rates more than three times higher than during the Great Depression, meaning super funds that invest in a highly diversified portfo­lio of investment grade credit are likely to be compensated for the risks that they are taking regardless of whether spreads still blow out, new research has found.  Research from Melbourne-based Omega Global Investors titled High Investment Grade Credit Opportuni­ties for Institutional Investors revealed implied default rates for US corporate bonds at March 31 this year were 38 per cent for corporates and 53 per cent for financials.   

The worst default rate since 1920 for corporates was 9.2 per cent, accord­ing to the research.   “If 9 per cent of corporates de­faulted in 1931, imagine what the world would have to look like if 38 per cent of companies defaulted,” said Mathew McCrum, director of investments at Omega Global Investors.  “We think the risks are overdone compared to what the market is imply­ing.”  George Vassos, managing director of Omega, said the implied default rate of non financials, which according to the research is 26 per cent, had overshot.   

“The nervousness on financials glob­ally is dragging up default rates across the board,” he said.   “If you were to lock down where that opportunity sits, it’s in the non financial sector.”  The research showed that if cor­porate credit spreads blow out to 8 per cent, the return from this increase will be -3.96 per cent, but if spreads drop to 4 per cent, the return from the reduc­tion will be 7.42 per cent. 

McCrum said that the caveat is that the portfolio must be highly diversified. Omega believes that market cap bench­marks are inefficiently constructed and do not provide sufficient diversification.   Those companies that issue the largest amount of debt claim the highest weightings in the benchmark, yet they are not necessarily the most financially healthy organisations, McCrum added.   

“General Electric is 4 per cent of the global credit benchmark; that’s not diversified,” he said. “50 per cent of the index is made up of financials.”  Omega’s Global Credit Opportuni­ties strategy seeks to generate a return greater than Barclays Capital Global Aggregate Index over rolling three year periods, and control risk by maintaining a broadly diversified portfolio of corpo­rate bonds from around the world. No more than 0.75 per cent of the portfolio is invested in a single issuer. 

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