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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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