In the search for yield in fixed income, investors have developed something of a herd mentality and piled into debt issued by some of the world’s most indebted countries.
It is a phenomenon driven by index-based investing which Andy Seaman describes as “bonkers.”
“Over time that indexation has seen more and more money driven into bonds issued by debtor countries,” says Seaman, Stratton Street Capital’s London based executive partner.
“The crazy situation is that most bond funds hold more debt issued by Hungary than they have exposure to China, which is mad.” Stratton Street’s approach is to invest only in investment grade bonds from countries, and companies within those countries, which they consider have the greatest ability to pay their debts. At the head of this list are countries such as Qatar, Singapore the UAE and Taiwan.
The criteria used to make this distinction is the Net Foreign Asset (NFA) position of a country, which is the value of assets a country owes abroad minus any debt owed to foreigners. Countries with negative foreign assets of 50 per cent or more are excluded, which also means Australia – with an NFA position of more than minus 80 per cent.
The result is Stratton’s New Capital Wealthy Nations Bond Fund, a US$1.3 billion fund the firm is currently touting to institutional investors, family offices and private banks in Australia. The fund has achieved a yield of 7 per cent while maintaining better quality than competing investment grade corporate bonds or corporate bond funds, which typically yield up to 5 per cent.
The strategy is long only, with no use of leverage. Leverage is a term Seaman likes to use to explain his investment philosophy. “As the world deleverages, one by one the countries with a poor NFA position are being exposed,” he says. “And they are paying debt back to the credit countries, and in our fund that means we can give investors relatively high yield and a good risk/reward profile. Stratton also has a smaller – US$230 million or so – Renminbi Bond Fund in $US terms delivered a 15.3 per cent return in 2010 and 9.73 per cent lat year.
The strategy is to invest in $US dollar denominated assets hedged into Renminbi, providing investors with higher liquidity and a higher yield than direct investment in the Renminbi bond market. Andy Seaman says the fund is driven by his conviction that the Renminbi could double in value over a decade if growth is allowed to continue and the exchange rate restrictions relaxed, even gradually.
“I think one of the few certainties in life is that investors will have more exposure to the Renminbi in future than they do today,” says Seaman.