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One of the biggest challenges facing fixed income investors today is how to achieve attractive returns in a dysfunctional market environment. In such a climate, global, unconstrained credit strategies can prove their worth, as they have the freedom to pursue opportunities throughout global credit markets, without being limited by traditional benchmarks.
The current volatile, low-yield environment calls for a strategy that has the flexibility to benefit from opportunities where and when they arise. An unconstrained strategy such as Robeco Global Credits invests largely in investment grade credits, but has the flexibility to invest also in high yield, emerging markets and safe, liquid securitized debt. The portfolio manager pursues a value-oriented investment style, identifying credits which are cheap relative to their fundamentals and are expected to mean-revert. Risk is limited by diversification, thorough research by an experienced team of analysts, and the integration of risk management in the entire investment process.
It is our conviction that credit markets are impacted by behavioral biases. Too often investors get hung up in a fear & greed mentality. So when markets panic we see opportunity, If everyone is buying we look at selling if we do not get paid for the risk we take.
An example of a behavioral bias we often see is that people experience the ‘feeling of losing’ one euro more intensely than the ‘feeling of winning’ that same euro. This fear of losing is an important driver of market prices, and causes abrupt selling at any price. This creates opportunities.
Other biases are the home market bias and the tendency to over-appreciate recent events and extend the trend. Investors simply overreact. Value can also be caused by market segmentation. Investors sometimes buy credits they should not have bought. For example, an investor may have bought credits that were just outside his mandate (BB credits in an investment grade portfolio). They do this to obtain short-term gains, without fully appreciating the risks or lacking research resources. Panic or fear can then drive selling pressure.
These biases and segmentations cause value opportunities. After the initial overreaction, value investors realize events have caused credits to become too cheap and offer over-compensation for the risk (value). Our quantitative research shows that valuation in investment grade credit tends to mean-revert over time. Shorter dated cheaper credits appear to offer the best opportunity. A continuous flow of positions in such credits has great rolling-down-the-curve impact, therefore offering both return and yield.
You do not want to buy credits that are cheap for a reason, though. Fundamental research is necessary to screen out ‘cheap-for-a-reason’ candidates.
What is the advantage of a global approach? First and foremost, it offers a much broader opportunity set due to geographic diversification. Some sectors or segments of the market are much better represented in one region than in another. Also, the fact that various regions are in different stages of economic and market cycles offers opportunities for uncorrelated positions. In such a broad opportunity set, there are always value opportunities somewhere. With our research set-up, which integrates investment grade, high yield, emerging and developed credit analysts, we are well positioned to capture these opportunities. We look for opportunities across markets where we get well paid for the risk we take.
With an unconstrained global set-up, a strategy can be very active and at the same time selective in the management of the portfolio. In emerging markets, for example, differences in expected returns can be very pronounced. We can set up short positions if market segmentation or client hoarding has made a region to expensive. This can be combined with a long position in a cheaper region. Or when a central bank’s policy has made one region to expensive, there is always another region where recession has just set in. By taking advantage of the difference in business cycles, it’s possible to create alpha.
There are also various opportunities in the cross-over segment between high yield and investment grade. We identify rising stars or, on the other hand, investment grade names that are moving towards high yield. These can be under severe pressure but recover sharply once they actually move over to the high yield category, finding a new investor base that looks at the return perspective more favorably.
The integration of Environmental, Social, and Governance (ESG) factors into the credit analysis can be a valuable addition to traditional financial data. It provides extra information that can help avoid the losers in the portfolios, which is more important than picking the winners. For example, weak corporate governance can lead to serious downside risk, such as fraud or default, whereas good governance is less likely to result in a credit quality improvement. ESG integration is therefore a further step in mitigating downside risk while capturing the value premium.
Even in the current low-yield, central bank-driven investment climate, it is possible to achieve attractive returns on credits. With an unconstrained global credit strategy, it is possible to take advantage of the full spectrum of opportunities the global credit market has to offer.