As Jon Jonsson, managing director at Neuberger Berman put it: “The magnitude of the moves are in no relation to the underlying risks and outlooks. This has led to episodes of sell-offs, but pension funds need to be patient and tactical in order to take advantage of the dislocations in the market and lock in attractive valuations and better yields.”
DEUTSCH THE WAY TO DO IT
One of his preferred trades is to sell 30-year German bunds in favour of buying its similarly long dated US government counterparts.
“If you look at the relationship over the past 20 years, it never exceeded 100 basis points (bps), but now with the European Central Bank’s latest quantitative easing programme, the spread has blown out by 200bps,” he says. This dislocation is attractive because we believe the growth differential between Germany and the US implied by this spread is not sustainable over a long period of time.”
High yield and investment grade bonds as well as leveraged loans also garner a strong recommendation although selectivity is key given the stage of the credit cycle.
“We are late in the cycle and corporates are more levered and spreads have come in,” says Adam Smears, head of fixed income research at Russell Investments. “There is a potential that there could be a sell-off as we run into summer, but there are opportunities. We believe a good starting point is to buy shorter duration, high quality high yield or low quality investment grade bonds. I view this as the yield engine, but I would add alpha diversifying strategies such as trading currencies and rates to smooth the pathway.”
In general though, European corporates, particularly in the high yield arena where returns are roughly 5.2% versus the roughly 1.1% in investment grade, are the favourites. Investors are more wary of the US, because although performance is slightly better at about 6%, the beleaguered energy and mining sectors are casting a pall. Analysts predict they could push the total percentage of defaults to a lofty 5-6%, up from roughly 2% last year and the long term average of 4.4%.
“High yield has seen a lot of stress but if you strip out energy, then there are companies that have strong fundamentals and balance sheets,” says Sorca Kelly-Scholte, head of EMEA pensions solutions at JP Morgan Asset Management. “There are also opportunities in Europe, but the yields are lower because of the higher quality of the corporates and less exposure to the energy industry.”
TRADING UP
The US-based fund manager has shifted its portfolio towards those sectors, however, sitting at the higher quality and more defensive end in both the US and European high yield markets.
Andreas Michalitsianos, executive director and portfolio manager in European investment grade corporate credit, says: “In both regions we have an up in quality bias within high yield. Sectors where we see value are autos along with cable, healthcare and utility companies because they tend to have a more transparent and stable cash flow profile. We are also allocating to European investment grade because although the yields are lower the technicals are strong primarily due to the stimulus from the ECB and Bank of Japan.”
US investment grade credit has also taken a hit. Moody’s downgraded more companies in the first three months of the year than in the whole of 2015. Overall, 51 corporates slipped into junk territory, up from eight in the fourth quarter and 45 in 2015. Almost half emanated from the oil and mining industries.
