(Pictured: Katrina King)
QIC has produced a research note to support expanding the range of fixed interest investments, including long/short strategies, as a way to mitigate against the adverse effects of a rising interest rate environment.
Katrina King, director of “global liquid strategies”,research and strategy, at QIC, which includes traditional sovereign bond investing with credit and other alternative debt strategies, says: “We think it’s time for fixed interest investors to dust off their balance sheet analysis skills again.”
The research note, which QIC calls a “red paper”, says: “The prospect of rising interest rates is not a sufficient reason to abandon fixed interest investing. It does, however, call for a review of how funds take their exposure to the asset class. The key to successful management of fixed interest will be gaining the correct exposure to the asset class’s risk/return drivers: interest rates, credit and inflation.”
King says that the environment for credit, now, is more akin to the days prior to the global financial crisis when investors needed to study the names and industries in which they were investing their credit budget.
“It’s been a great run [for credit] but investors shouldn’t get complacent given that we’ve been correcting from a huge illiquidity premium which arose in 2008,” she says. “The credit investor has to think about disentangling credit from bond yields.”
This can be done through active hedging strategies, but the research note says this should just be the first step. Corporate credits must be disassembled and sources of risk and return individually and actively managed, the paper says. QIC is expecting the “corporate tightfistedness” of the post-GFC period to fade as shareholders demand higher returns and cracks appear in corporate conservatism.
The paper says: “Only intensive industry-by-industry and company-by-company credit analysis will be able to detect the fractures. Some companies will be downgraded as they return more money to shareholders, invest in new businesses or get taken private. Others will be upgraded on the back of a stronger economy, execution of turnaround plans, get purchased by stronger competitors or use buoyant sharemarkets to raise equity.
“The time for looking at corporate bonds as a generic investment category is coming to an end. Rather than blandly investing across the credit spectrum on a generic basis, the credit investor needs a manager with experienced credit analysts and active management capabilities.”
King says there has not been much cap-ex among big corporates in the US or Australia in recent years. Corporate revenue, in aggregate, has been rising less quickly than GDP and companies have been squeezing their costs to increase profits. They can’t keep on doing that.
QIC likes long/short pairs trades as a way of generating alpha, especially in the current environment of squeezed credit spreads and generally rising interest rates. It also likes to participate “down the credit curve”, such as among Australian sub-debt (bank debt), where King says the manager is better rewarded for its analysis work and where there is better value for the investors. The firm has about 20 investment professionals in its fixed interest team.
While the recent paper does not include QIC’s views on emerging markets debt, King observes that that sector “has got a bit of wind behind it” in recent weeks, compared with its “dreadful start” to the calendar year. As of last week, there had been two weeks of inflows into emerging markets equities, according to agencies, and three weeks of emerging market debt inflows.
King says that there has also been some flow back into Australian Government bonds and trades by some US hedge funds involving shorting Australia, along with China, seem to have been reversed.
