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Inappropriate Labels

As markets again oscillate around tariffs and the latest tweets from Donald Trump, we thought we would avoid adding to your list of commentaries on that subject and instead focus on a long-standing gripe of ours – inappropriate labels and our industry’s desire to sell product made for institutional investors rather than solutions for the retail/individual investor.

In May’s mid-monthly update we take a look at bond markets, for so long a significant portion of old-fashioned balanced mandates – usually without a target outcome that investors can understand (unlike our multi-asset Dynamic Fund I should add).

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The industry tends to refer to bonds as fixed income – you rarely hear of a Head of Bond Investing or Debt which is what the major alternative to equities is – Debt.

Debt comes in two forms primarily – fixed and floating.  Investment firms rarely use the word debt – as it has negative connotations – but debt is the all-encompassing term that covers the asset class.

Debt is broken down (usually under the banner of fixed income) as follows:

Rates (domestic sovereign debt – e.g. Gilts for UK investors, Treasuries for US etc.)

Sovereigns – governments borrowing in other currencies

Corporates – investment grade

Corporates – high yield

Emerging Markets

This usually means three teams, maybe four depending on whether 1-3 are lumped together or not.  But the real problem is the hard lines and demarcation between those teams.

The successful application in credit is in crossover – those corporates either side of investment grade – BBB and BB.

Ignore domestic government debt and everything else should fall into investment grade or high yield – sovereign, EM and corporate debt alike.

To B or not to B?

The sweet spot is in the B’s – avoiding BBB investment grade credits before they trade like high yield (the rating change usually follows after the price and yield move) and become ‘fallen angels’ and investing instead in improving credits in single and double BB credits who become ‘rising stars’.  The skill is in the credit analysis.

At a time when yields on most forms of debt are fairly miserly and below inflation in most cases, many investors are taking on more credit risk to attain a higher yield.  Some less experienced private investors have become seduced by even higher yields on mini-bonds.  That doesn’t always end well.

The industry template within large investment firms is to have three to four investment teams – investment grade, high yield and EM, usually measured against an index weighted by issuance.  Imagine being drawn to lend to those that want to borrow the most?!  Granted there are now indices that account for financial strength but hopefully you get where I’m coming from.

The sweet spot in crossover is often missed.

There are some absolute return credit funds that are index agnostic and look at investment grade and high yield but not many and some have capacity constraints. Why aren’t there more – especially aimed at retail investors not hamstrung by the size and limitations of large institutional investors?  To be successful in crossover, absolute return debt, you need good credit analysis skills which may and should involve speaking to equity colleagues.  Those that operate in silos are missing out and importantly, so are their clients.

PS There’s no need to separate out EM.