Managers defend economics of corporate credit

Portfolio managers have taken a broadly positive view of the global economy and the prospects for fixed income, offering perspective on China’s slowdown and arguing the environment would remain supportive of corporate credit.

Speaking at AsianInvestor’s ninth annual Korea Institutional Investment Forum in Seoul this week, speakers agreed that while the US Federal Reserve should perhaps already have started raising rates, it was being constrained by the fact the world was still overloaded with debt and inflation was too low.

They all forecast a continuation of low interest rates for some time, with the prospect of further monetary easing in Japan and Europe to remain supportive of companies. While policy divergence would create further volatility and more prominent liquidity risk, they noted many corporates had cash and were profitable, underlining the need for investors to discriminate in company selection.

Moreover, they argued the US economic recovery was real. While China’s slowdown was a valid concern, it could be contained and besides Chinese authorities had further room for economic stimulus. The key to investing in corporate credit was diversification, they suggested.

Niall Quinn, managing director and president, Eaton Vance Management (international), told the forum that investors should take lessons from Japan, which has suffered years of rock-bottom interest rates.

He pointed to floating-rate loans as an area that Japanese investors had focused on in recent years, minimising duration risk from rising rates. This was an area global investors should look at, he urged.

In support of his argument that corporate bonds (investment grade and high-yield) would remain viable, he noted the US and Europe were in recovery mode, with little prospect of recession in advanced economies.

He observed the US was on track to see 3.7% annual GDP growth, with job creation at its highest level since 2006 and signs the US consumer was regaining confidence as sales of new vehicles were higher now than for years.

While he conceded the world had become nervous about China’s economic slowdown, he noted China still only represented 13% of global GDP. “That suggests the China situation can be contained at a global level,” said Quinn. “While we recognise its [China’s] importance, it is dwarfed by the US economy.”

He pointed to continued quantitative easing combined with profitable corporates as supportive for credit investors, along with increased liquidity in sub investment-grade debt. “The world economy is in reasonable shape, but there is a need to discriminate between countries and companies,” he said.

Pilar Gomez-Bravo, a London-based global credit manager for MFS Investment Management, noted that investors could expect continued volatility from divergence in monetary policy, creating financial stress in market liquidity, currency and commodity prices. “As investors, you will need to operate with more caution,” she said.

She, too, observed that the US consumer – representing 70% of US GDP – was in good shape, having enjoyed income growth combined with reduced household debt. “Household net worth is now at record levels,” she noted.

She added that corporate profits as a share of GDP had also been rising consistently. While she conceded she would like to see more signs of a pick-up in US consumer spending, she said low commodity prices would be help. She added that the Federal Reserve had forecast its tightening cycle would be one of the most benign on record.

She suggested the environment was now ripe for mergers and acquisitions, combined with corporate releverage. “We are entering an M&A environment and will see the leverage cycle pick up,” she said.

Meredith Birdsall, client portfolio manager at Pioneer Investments, reminded investors what their fixed income portfolios were supposed to be for: “Stability, income and to serve as a diversifier,” she said.

She advocated a multi-sector approach to fixed income to combine risk factors that were less correlated to interest rates than duration risk. “You can still include duration in your portfolio, but you want to mitigate that by including disparate risk factors,” she said.

She reminded the audience that rebalancing was a big force in returns. “It speaks to being a contrarian investor,” she said. “You need to believe in mean reversion and look at risk-reward. It is about being a value investor at a time when you least want to.”

Birdsall argued that investors could access a range of fixed income opportunities and be dynamic in the way they approached them with multi-sector, while taking into account correlation across segments.

“Multi-sector gives you the opportunity to be tactical,” she said, observing that in 2008 catastrophe bonds became the second most liquid asset class outside US Treasuries, while municipal bonds offered an opportunity in 2011. “You do not just want to go after returns, that is what this year has taught us,” she concluded.