“Pretty meagre” returns for fixed income assets are prompting managers to move into riskier senior secured loans, high-yield emerging markets and asset-backed securities, CQS portfolio manager Darren Toner has said.
Toner, a credit, multi-asset and global high yield specialist, said only 21 per cent of global credit markets are getting above 1 per cent return at the moment, prompting active managers to increase risk with unconstrained investments.
“I’m bullish in credit, there’s a 5 per cent delta and a liquid market,” Toner told the Investment Magazine Fixed Income and Credit Forum in late July, during a panel discussion titled “Unconstrained approaches to fixed income”.
“Loans are a US$1.2 trillion global asset class and interest coverage is at its peak, which is very positive, with the ability for corporations to pay their interest at [historical] highs,” he said. “Global leverage has certainly come back into the system but we’re not at global financial crisis highs.”
Corporate loan default rates were at historical lows of 2-2.5 per cent in global high yield, which was “quite attractive right now” but US high yield market defaults had been clustering in certain sectors during the last 12 months.
“It’s a credit picker’s market. You need to be active, otherwise you’ll end up owning defaults,” Toner said.
A recent flood of cash has moved investment-grade bonds, causing US investment-grade markets to produce a negative 3.5 per cent return; US loans, in contrast, were returning 2 per cent, he said.
CQS was avoiding investment-grade assets and buying asset-backed securities, asset loans and short-duration, high-yield floating rate products, Toner said.
Colonial First State senior investment manager George Lin, another panellist, said his team had used unconstrained credit outside its traditional fixed income strategy for the last five to six years.
A co-defensive alternative strategy targeting returns of the cash rate plus 3 per cent was complementary to CFS’s mainstream fixed income strategy and allowed managers to invest outside the benchmark and manage duration more aggressively, Lin said.
CFS’s second unconstrained strategy was multi-asset and alternative, targeting a return of cash rate plus 4-5 per cent.
Avant Mutual Group chief investment officer John Lucey was also a panellist. He said the insurer’s unconstrained global-oriented credit strategy targeted CPI plus 4 per cent growth.
“We know we’re not going to get equity-like returns but there’s less volatility and it allows us to take more risk elsewhere in the portfolio,” Lucey said. “We’re not looking for a tail-risk hedge. We’re looking for something that can stand on its own two feet and deliver return. The dream is uncorrelated returns.”
Avant is on a global search for another fixed income investment manager to deliver absolute returns. Finding the right candidates is a challenge.
“When you take the benchmark away and say ‘I want an absolute return’, a lot can’t do it,” Lucey said. “Many claim we’re a credit fund with an overlay. Generally, fixed income managers don’t make good currency managers.
“Treasury guys can get returns of 2.6 per cent, that’s really my benchmark. When I look at absolute return managers for a cash (rate) plus 2-4 per cent return, there are few that can deliver on that.”