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CAMRADATA Multi-Sector Fixed Income roundtable

Black Swans in the vicinity
Parandian then asked the managers if they saw more shocks ahead. “I am more of a pessimist,” she admitted. “What would be the black swan event in the second half of the year?”

Hussain said it was a tricky question to answer when the black swan was a metaphor for what you never expect to see. Nevertheless, he suggested turning off the gas flowing into Germany would be the catalyst to tip Europe into recession.

“I’ve seen forecasts of a shrinkage in GDP of 3-12% as a result,” he said. “It’s an incredibly high risk: spread duration rather than rate duration protects you here”.

Hussain recommended simplifying investment decisions, with an emphasis on cashflow predictability. “If it is a deep recession, be prepared for it. Don’t be too greedy”.

He said RLAM’s yield was currently almost 8% with spread duration of only 2-3 years, which he described as very healthy characteristics to buffer against a rise in defaults.

“We have financials who’ve taken a bit of a haircut,” said Desqueyroux, “which is definitely a stockpicking consideration. The flight to quality didn’t happen but in the next few months it might”.

Switching scope to the micro, he recommended big names that had sorted out their cost base and customer loyalty, thereby improving their strong value-chain. “In High Yield, you can envisage companies with smaller balance sheets with targeted pieces of the value-chain, and more likely price-takers. If these issuers hadn’t sorted out their cost structure last year, they will feel the pressure,” warned Desqueyroux.

He did note that with short-duration holdings, even if there are company-specific problems, the Sanlam Credit Fund will see 20-25% of its capital coming back within twelve months. With this cash to reinvest, Desqueyroux described its current strategy of small steps to improve credit notches while still pushing the yield up by 1-2%. “That is our mindset,” he said. “Earlier in the year, we felt we had to compensate for losses. Now we move closer to the safe places higher up the capital structure”.

Fleury concurred that recession was almost certain in many Developed Markets but may not happen simultaneously across countries. “Central banks find themselves in a position where they need to engineer a slowdown to control inflation,” he said. “We are therefore structurally cautious”.

Fleury said that assessing the market implications of a Black Swan event (such as major gas supply interruption in Germany) is complicated by the possible reaction functions of central banks and governments, which are hard to predict. “As a manager, you have to work through scenarios rather than just base cases,” he said.

“We tend to go back to trying to find good credits,” he continued. “If we can avoid those worst-affected companies and sectors, then over the long run we can avoid defaults material eating into that 8% yield”.

Fleury felt that Desqueyroux was perhaps oversimplifying with his division of Investment Grade and High Yield vis-a-vis pricing power. “From a business perspective, a large HY company may have as much pricing power as an IG one,” said Fleury. “It is true that an IG company may have greater financial resilience to absorb costs that they cannot pass through”. But he noted the market price risk of an ailing IG issuer slipping to below IG.

“It’s an unusual environment,” said Hussain. “Companies have built up inventories that won’t get sold. Auto suppliers, for example, are de facto leveraged liabilities for the car manufacturers. They aren’t on balance-sheet but the latter cannot function without them”. He suggested supermarkets were in a similar relationship with their big suppliers. Thin margins exacerbate this problem and were the suppliers to go bust, supermarkets would suffer. To complete the picture, Hussain noted that as a result of two major leveraged buy-outs, more supermarkets in the UK had fallen to High Yield status, with much of that debt sitting in private credit hands

“The background seems dark,” said Parandian, “but as so often is the case, we see concurrent opportunities. When is the right time to buy into weakness?”

Hussain replied that you look for contractual cashflows, from the likes of cable operators. “It’s not just about ratings. If you look at BBB-, it is an incredibly risky segment of the market. High Yield, on the other hand, has become higher Quality than historically; and the BB names in the HY market look pretty resilient”.

Desqueyroux saw attraction in cashflows from utilities via their senior debt. Within Financials, he recognised that the banks have had a tough time on the equity side but that has resulted in a decade of improving capital strength.

Sanlam is even more constructive on insurers. Desqueyroux noted that they do not take the direct hit from soaring food or energy prices. Having said that, they will face inflated claims but Property & Casualty departments will have the opportunity to readjust premiums. And that is after a period during COVID of low claims. “In the last few years, insurers were facing a lower-rate environment urging them to get a more efficient operational model. Now their investment portfolio will also contribute to the bottom line,” he said.

On income, Fleury said the Janus Henderson MACS was achieving around an 8% yield. “That yield is going up if rates go up because so much of what we own is variable-rate,” he added. Like Hussain, he reckoned that the Janus Henderson MACS strategy has a material income cushion to absorb losses if they come through.

On macro-politics and dark shadows, Kerr said that Germany can afford to continue to use fossil fuels for its energy production even if it strains the national commitment on decarbonising. He could not, however, see the Ukraine conflict ending quickly. “It could take years to resolve, which will have a huge impact on inflation in energy, transportation and grains”.

For Kerr, that matters more for bond portfolios than equities. He said that consumers’ changes of habits of consumption come through in credit spreads faster than equity prices.

Chavda said that from his perspective, consultants are much less equipped to forecast macro-shifts than asset managers: “In fast-moving environments such as this, consultants need to stay close to managers to understand the thinking process behind changes to portfolio asset allocation on both a strategic and tactical basis”.

He said he was less pessimistic than Kerr about fixed income. He distinguished, especially with regards to MACS, between high conviction and high returns: “When it comes to fixed income, for the most part, investors are not expecting to shoot the lights out; it’s more of a measured approach to seeking the best risk-adjusted returns with a view to minimising the downside. Those MAC strategies that focus on sub-investment grade securities need to take a higher conviction approach to portfolio construction as they are more exposed to the asymmetric nature of the fixed income risk profile and subject to a lower degree of liquidity in their underlying assets”. said Chavda.