Cooney then explained a research project he conducted at LCP’s research partner (Frontier Advisors) in Australia to look at attribution of returns by MACS: the twin goals were to work out how to assess a manager by security selection with regard to outperforming an index; and secondly, manager skill in terms of dynamic allocation between sectors of credit.
“It is difficult to assess individual credit selections,” Cooney told the CAMRADATA panel. “But if you look at sector rotation between sub-classes, such as Loans and High Yield, there is not much evidence that managers could switch at the best times”. There was evidence, however, for beneficial “off-benchmark” sector allocation. Managers who went looking beyond Loans and High Yield could increase returns considerably. “Looking at managers over time, they trace a line: High Risk; High Return,” said Cooney. “But when they add more sectors, they start to go to the top left of the chart. We found managers doing a bit more in the tool kit were adding value and expect this to hold in the current environment”.
McLean said multi-credit managers in the previous period had outperformed more because of their top-down asset allocation calls but now, in a much more dislocated world, active stock selection is going to add the most value.
Hussain agreed. “Post-Global Financial Crisis, it has been a pretty benign climate,” he said. “Defaults haven’t been significant; central banks have ridden in hitherto to support markets. Now we are likely to be in a structurally higher default climate. So this time is different. We are not in control of every risk, especially in High Yield, so it’s really important to know your credits from a bottom-up as well as top-down perspective. There is a long tail of names for which you don’t know the likely outcome in a recession, so you could end up with far more losses by being overdiversified”.
Kerr was asked whether multi-sector credit managers were claiming top-down allocation skills when in fact it was mechanistic rebalancing, something that would have happened anyway. Kerr said: “We see some of this: managers using asset allocation to hedge divergence in return-targeting”. But he reckoned that ultimately it was hard to attribute skill in allocation calls. “Ultimately managers need to be better at demonstrating the impact of their dynamic asset allocation decisions and how these differ from mechanistic rebalancing”.
Kerr did follow McLean and Hussain’s point that stock selection was going to matter going forward because we have had such a benign environment for credit throughout the last decade.
Desqueyroux said that we are experiencing an ongoing difficult situation, which governments would be tempted to address as before. “We have created an addiction. I struggle to see a sustained recession without further intervention”. But he said it was hard to predict which sectors would be well looked after. That kind of unknown would impact portfolio management.
Kerr suggested that the cynical take on rising rates from the Fed and Bank of England was to give them headroom in eighteen months’ time to cut rates.
“I don’t think that is a cynical view at all,” responded Fleury. “It’s a natural reflex of central banks given the position they are in”.
He said that the jury is still out on how quickly consumer demand will turn around. He sensed that recessions were still six to eighteen months away.
“From a rate perspective, the US has a real inflation issue,” he said. “This is not just about commodity prices: there is wage inflation there”.
Desqueyroux added there were already comments coming from U.S. companies that they have overstaffing and will be freezing hiring and IT projects. On the U.S. labour force, he noted that over the last five years there has been a 700,000 shortfall due to a lack of immigration but also early retirement during Covid. The latter may have to partially come back in a recession scenario.
“Although I feel fundamentally cautious, I believe that now will still prove to be a good time to invest in MACs,” said Fleury. “There is risk of more spread-widening, but I believe it will turn out to be a decent time to be investing, especially if our stockpicking remains strong and we use the asset allocation optionality within the strategy well”.
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