Two ways credit can add relative value as the cycle turns

10/08/2020
Two ways credit can add relative value as the cycle turns

Summary

The risk/reward profile of corporate bonds is less attractive now than when the coronavirus crisis began. Since then, bonds from higher-rated firms have been buoyed by central bank support. As the credit cycle turns, we suggest prioritising both issuer and security selection to seek outperformance – potentially with fallen angels and secured bonds.

Key takeaways

  • The risk/reward balance in corporate credit remains attractive, but less so than in March and April
  • Multi-sector and high-yield strategies focused on relatively undervalued assets have the potential to outperform, whether the credit rally continues or turns out to be fragile
  • Healthy and improving debt dynamics are critically important for issuer selection
  • As we move into a new stage of the credit cycle, security selection will be key to adding relative value to credit portfolios

According to the Bank for International Settlements, 50% of firms globally may have insufficient cash flows to cover debt-related and operating expenses for 2020. This may push many credit investors higher up the rating spectrum as they seek to avoid potential distress in lower-quality credits. However, such an approach brings two main risks to performance.  

  • First, many of these higher-rated bonds are already back to trading close to par, or their full value. This means their prices are less likely to appreciate further, so investors may only get returns from the bonds’ coupon payments.
  • Second, high-yield investors may run the risk of not earning the full yield-to-maturity because issuers can “call”, or redeem earlier, a large share of bonds to refinance the debt at lower rates.

One possible solution is to invest selectively in so-called “fallen angels” – issuers that have been downgraded to high yield, but which may go on to regain investment-grade status. 

Seek out selective and defensive exposure to fallen angels

Fallen angels consist largely of non-callable bonds that may offer relative value, in the sense that they trade at deeper discounts than would be suggested by their credit fundamentals and peers. Historically, fallen angels have outperformed the broader high-yield market, as illustrated in Chart 1. 

Credit-adding-relative-value-EN-Cht1

However, fallen angels in aggregate may not be offering quite as much value as they have in the past. As Chart 2 shows, fallen-angel credit spreads have not widened, or “cheapened”, as much in the current crisis as in 2008-2009, indicating that these issuers may offer less relative value than they did in the past. One possible factor behind this has been the unprecedented move by central banks to buy, or accept as collateral, bonds issued by fallen angels. By pushing up the prices of these bonds, this form of systemic stimulus can mask the remaining risks that are specific to each firm, and it can cap the potential for excess returns from fallen angels as a group. Research shows that only around one quarter of fallen angels make it back to investment grade, so it’s important to take a highly selective approach when investing in these securities.

Credit-adding-relative-value-EN-Cht2

Moreover, a defensive way to add to or to hedge fallen-angel exposure is through “long” or “short” positions in corporate credit-default swap (CDS) indices. Long positions on these exchange-traded derivatives gain in value when there is an improvement in credit quality in the underlying unsecured bonds (which are insured against default by CDS contracts). CDS indices are relevant because fallen-angel and crossover securities tend to dominate CDS markets more than lower- or higher-rated securities. Also, CDS indices are usually more liquid than cash bonds, which can help CDS outperform as credit conditions improve.

There is value within the secured bonds universe 

Secured bonds offer an alternative way to add relative value to credit portfolios, even if the segment may not look that attractive at first glance. Chart 1 shows that secured bonds have underperformed the fallen-angel universe and broader high-yield bond market – which are made up of approximately 5% and 20% of secured debt, respectively.

Intuitively this makes sense. Secured bonds offer greater loss protection, so they should command a lower risk premium. They have seniority over unsecured bonds and are collateralised with company assets and other guarantees – which has historically given them much higher recovery rates (more than 65%) in the event of default. For example, when an issuer is downgraded from a BB to a B rating, its secured bonds can trade at credit (risk) spreads as much as 200 basis points lower than their unsecured counterparts. Moreover, secured bonds have shorter duration on average, which can help smooth the impact of longer-term volatility in interest rates and spreads.

We think it’s particularly worthwhile to look at secured bonds now because major credit downturns usually prompt companies to pledge various forms of collateral in order to attract financing, potentially making their secured bonds even more attractive. For instance, in 2009, following the global financial crisis, the proportion of new corporate debt accounted for by secured bonds rose by several multiples year-on-year. This credit-cycle downturn has been similar, with April marking a record high so far in the volume of secured bonds issued globally each month.

However, unlike in 2009, credit spreads today more closely resemble those of the broader high-yield market. This means that on a loss- or recovery-adjusted basis, there will likely be bargains to be found within the secured bonds universe. This may be because many investors remain cautious, perceiving the increased issuance of secured debt as predominantly a sign of distress. But in a crisis as deep as the current one, healthier issuers are just as likely to issue secured debt as those that go on to default. Experienced credit managers with large research teams can often buy high-quality secured bonds at much higher-than-usual yields, especially in the primary market.

Since March this year, we have seen at least two examples of new secured bond issues that subsequently paid off on a relative value basis. 

  • One firm with a B rating was under pressure to fund cash needs and refinance bank loans, so it issued new secured bonds at double-digit yields more typical of CCC rated debt. 
  • Another high-yield issuer needed to pay down existing unsecured bonds that carried higher coupons, so it tapped the primary market with secured bonds that were rated investment-grade but actually yielded more than comparable securities.

Both issuers had at least one common characteristic: they did not issue as much secured debt in good times, leaving unencumbered assets at hand to pledge as collateral in bad times. A healthy loan-to-value ratio – ie, a relatively low level of debt compared to a company’s secured assets – became an important metric to consider when future earnings visibility vanished as economies went into lockdown.

Whether or not the credit rally continues, focus on relatively undervalued assets 

Looking ahead, the risk-reward balance in corporate credit remains attractive, even if less so than in the first quarter of 2020. Higher-quality high-yield credit may be more skewed to income than capital gains for now, but we still see significant upside and lower downside in select fallen angels and secured bonds. Focusing on relatively undervalued assets may be more likely to deliver outperformance, whether or not the credit rally continues.

If credit spreads tighten further, identifying value relative to equivalent securities could help enhance returns for investors who feel they have missed out. Alternatively, if a “V-shaped” recovery does not materialise, repeated spread widening should push investors to prioritise liquidity and loss mitigation. Multi-sector and high-yield strategies – with a selective and defensive profile – have the potential to outperform in both scenarios.

 

> download

 

Duration is a measure of the sensitivity of the price of a bond to a change in interest rates. ICE BofAML Global High Yield Index tracks the performance of USD, CAD, GBP and EUR denominated below investment grade corporate debt publicly issued in the major domestic or eurobond markets. ICE BofAML Global Fallen Angel High Yield Index is a subset of ICE BofAML Global High Yield Index including securities that were rated investment grade at the point of issuance. ICE BofAML BB-B Global High Yield Secured Bond Index is a subset of ICE BofAML Global High Yield Index including all secured securities rated BB1 through B3, inclusive. The Markit iTraxx Europe Crossover Index comprises 75 equally weighted credit default swaps on the most liquid sub-investment grade European corporate entities. The Markit CDX North America High Yield Index is composed of 100 non-investment grade entities, distributed among 2 sub-indices: B, BB. All entities are domiciled in North America. It is not possible to invest directly in an index.

Why the coming months are critical to a decisive green transition

11/08/2020
Why the coming months are critical to a decisive green transition

Summary

As the world battles the Covid-19 pandemic, responsible investors can help make the economic recovery sustainable and inclusive by engaging with the right stakeholders. A PRI working group has developed recommendations for a policy-engagement framework to help guide the investment community’s actions. Here are highlights of the group’s findings.

Key takeaways

  • Sustainability objectives can be built into the financial stimulus and policy mechanisms that support the recovery from the downturn triggered by Covid-19
  • The coming months are critical to a decisive green transition, and research shows that many stimulus measures aimed at decarbonisation have high job creation potential and economic multipliers
  • Companies, investors, policymakers and other stakeholders must focus on social issues and human rights to build a fairer, more inclusive economy
  • Corporations should examine the role they play in promoting sustainability – and recipients of stimulus funds will need to demonstrate how they will create value for a range of stakeholders
  • To address the Covid-19 crisis effectively, investors have a clear role to play – but it’s also incumbent on the investment industry to act responsibly and encourage policy change

Allianz Global Investors

You are leaving this website and being re-directed to the below website. This does not imply any approval or endorsement of the information by Allianz Global Investors Asia Pacific Limited contained in the redirected website nor does Allianz Global Investors Asia Pacific Limited accept any responsibility or liability in connection with this hyperlink and the information contained herein. Please keep in mind that the redirected website may contain funds and strategies not authorized for offering to the public in your jurisdiction. Besides, please also take note on the redirected website’s terms and conditions, privacy and security policies, or other legal information. By clicking “Continue”, you confirm you acknowledge the details mentioned above and would like to continue accessing the redirected website. Please click “Stay here” if you have any concerns.

Welcome to Allianz Global Investors

Select your language
  • 中文(繁體)
  • English
Select your role
  • Individual Investor
  • Intermediaries
  • Other Investors
  • Pension Investors
  • Allianz Global Investors Fund (“AGIF”)

    • Allianz Global Investors Fund (“AGIF”) as an umbrella fund under the UCITS regulations has within it different sub-funds investing in fixed income securities, equities, and derivative instruments, each with a different investment objective and/or risk profile.

    • All sub-funds (“Sub-Funds”) may invest in financial derivative instruments (“FDI”) which may expose to higher leverage, counterparty, liquidity, valuation, volatility, market and over the counter transaction risks. A Sub-Fund’s net derivative exposure may be up to 50% of its NAV. 

    • Some Sub-Funds as part of their investments may invest in any one or a combination of the instruments such as fixed income securities, emerging market securities, and/or mortgage-backed securities, asset-backed securities, property-backed securities (especially REITs) and/or structured products and/or FDI, exposing to various potential risks (including leverage, counterparty, liquidity, valuation, volatility, market, fluctuations in the value of and the rental income received in respect of the underlying property, and over the counter transaction risks). 

    • Some Sub-Funds may invest in single countries or industry sectors (in particular small/mid cap companies) which may reduce risk diversification. Some Sub-Funds are exposed to significant risks which include investment/general market, country and region, emerging market (such as Mainland China), creditworthiness/credit rating/downgrading, default, asset allocation, interest rate, volatility and liquidity, counterparty, sovereign debt, valuation, credit rating agency, company-specific, currency  (in particular RMB), RMB debt securities and Mainland China tax risks. 

    • Some Sub-Funds may invest in convertible bonds, high-yield, non-investment grade investments and unrated securities that may subject to higher risks (include volatility, loss of principal and interest, creditworthiness and downgrading, default, interest rate, general market and liquidity risks) and therefore may adversely impact the net asset value of the Sub-Funds. Convertibles will be exposed prepayment risk, equity movement and greater volatility than straight bond investments.

    • Some Sub-Funds may invest a significant portion of the assets in interest-bearing securities issued or guaranteed by a non-investment grade sovereign issuer (e.g. Philippines) and is subject to higher risks of liquidity, credit, concentration and default of the sovereign issuer as well as greater volatility and higher risk profile that may result in significant losses to the investors. 

    • Some Sub-Funds may invest in European countries. The economic and financial difficulties in Europe may get worse and adversely affect the Sub-Funds (such as increased volatility, liquidity and currency risks associated with investments in Europe).

    • Some Sub-Funds may invest in the China A-Shares market, China B-Shares market and/or debt securities directly  via the Stock Connect or the China Interbank Bond Market or Bond Connect and or other foreign access regimes and/or other permitted means and/or indirectly through all eligible instruments the qualified foreign institutional investor program regime and thus is subject to the associated risks (including quota limitations, change in rule and regulations, repatriation of the Fund’s monies, trade restrictions, clearing and settlement, China market volatility and uncertainty, China market volatility and uncertainty, potential clearing and/or settlement difficulties and, change in economic, social and political policy in the PRC and taxation Mainland China tax risks).  Investing in RMB share classes is also exposed to RMB currency risks and adverse impact on the share classes due to currency depreciation.

    • Some Sub-Funds may adopt the following strategies, Sustainable and Responsible Investment Strategy, SDG-Aligned Strategy, Sustainability Key Performance Indicator Strategy (Relative), Green Bond Strategy, Multi Asset Sustainable Strategy, Sustainability Key Performance Indicator Strategy (Absolute Threshold), Environment, Social and Governance (“ESG”) Score Strategy, and Sustainability Key Performance Indicator Strategy (Absolute). The Sub-Funds may be exposed to sustainable investment risks relating to the strategies (such as foregoing opportunities to buy certain securities when it might otherwise be advantageous to do so, selling securities when it might be disadvantageous to do so, and/or relying on information and data from third party ESG research data providers and internal analyses which may be subjective, incomplete, inaccurate or unavailable and/or reducing risk diversifications compared to broadly based funds) which may result in the Sub-Fund being more volatile and have adverse impact on the performance of the Sub-Fund and consequently adversely affect an investor’s investment in the Sub-Fund. Also, some Sub-Funds may be particularly focusing on the GHG efficiency of the investee companies rather than their financial performance which may have an adverse impact on the Fund’s performance.

    • Some Sub-Funds may invest in share class with fixed distribution percentage (Class AMf). Investors should note that fixed distribution percentage is not guaranteed. The share class is not an alternative to fixed interest paying investment. The percentage of distributions paid by these share classes is unrelated to expected or past income or returns of these share classes or the Sub-Funds. Distribution will continue even the Sub-Fund has negative returns and may adversely impact the net asset value of the Sub-Fund.  Positive distribution yield does not imply positive return.

    • Investment involves risks that could result in loss of part or entire amount of investors’ investment.

    • In making investment decisions, investors should not rely solely on this [website/material].

    Note: Dividend payments may, at the sole discretion of the Investment Manager, be made out of the Sub-Fund’s capital or effectively out of the Sub-Fund’s capital which represents a return or withdrawal of part of the amount investors originally invested and/or capital gains attributable to the original investment. This may result in an immediate decrease in the NAV per share and the capital of the Sub-Fund available for investment in the future and capital growth may be reduced, in particular for hedged share classes for which the distribution amount and NAV of any hedged share classes (HSC) may be adversely affected by differences in the interests rates of the reference currency of the HSC and the base currency of the respective Sub-Fund. Dividend payments are applicable for Class A/AM/AMg/AMi/AMgi/AQ Dis (Annually/Monthly/Quarterly distribution) and for reference only but not guaranteed.  Positive distribution yield does not imply positive return. For details, please refer to the Sub-Fund’s distribution policy disclosed in the offering documents.


    Allianz Global Investors Asia Fund

    • Allianz Global Investors Asia Fund (the “Trust”) is an umbrella unit trust constituted under the laws of Hong Kong pursuant to the Trust Deed. Allianz Thematic Income and Allianz Selection Income and Growth and Allianz Yield Plus Fund are the sub-funds of the Trust (each a “Sub-Fund”) investing in fixed income securities, equities and derivative instrument, each with a different investment objective and/or risk profile.

    • Some Sub-Funds are exposed to significant risks which include investment/general market, company-specific, emerging market, creditworthiness/credit rating/downgrading, default, volatility and liquidity, valuation, sovereign debt, thematic concentration, thematic-based investment strategy, counterparty, interest rate changes, country and region, asset allocation risks and currency (such as exchange controls, in particular RMB), and the adverse impact on RMB share classes due to currency depreciation.  

    • Some Sub-Funds may invest in other underlying collective schemes and exchange traded funds. Investing in exchange traded funds may expose to additional risks such as passive investment, tracking error, underlying index, trading and termination. While investing in other underlying collective schemes (“CIS”) may subject to the risks associated to such CIS. 

    • Some Sub-Funds may invest in high-yield (non-investment grade and unrated) investments and/or convertible bonds which may subject to higher risks, such as volatility, creditworthiness, default, interest rate changes, general market and liquidity risks and therefore may  adversely impact the net asset value of the Fund. Convertibles may also expose to risks such as prepayment, equity movement, and greater volatility than straight bond investments.

    • All Sub-Funds may invest in financial derivative instruments (“FDI”) which may expose to higher leverage, counterparty, liquidity, valuation, volatility, market and over the counter transaction risks.  The use of derivatives may result in losses to the Sub-Funds which are greater than the amount originally invested. A Sub-Fund’s net derivative exposure may be up to 50% of its NAV.

    • These investments may involve risks that could result in loss of part or entire amount of investors’ investment.

    • In making investment decisions, investors should not rely solely on this website.

    Note: Dividend payments may, at the sole discretion of the Investment Manager, be made out of the Sub-Fund’s income and/or capital which in the latter case represents a return or withdrawal of part of the amount investors originally invested and/or capital gains attributable to the original investment. This may result in an immediate decrease in the NAV per distribution unit and the capital of the Sub-Fund available for investment in the future and capital growth may be reduced, in particular for hedged share classes for which the distribution amount and NAV of any hedged share classes (HSC) may be adversely affected by differences in the interests rates of the reference currency of the HSC and the base currency of the Sub-Fund. Dividend payments are applicable for Class A/AM/AMg/AMi/AMgi Dis (Annually/Monthly distribution) and for reference only but not guaranteed.  Positive distribution yield does not imply positive return. For details, please refer to the Sub-Fund’s distribution policy disclosed in the offering documents.

     

Please indicate you have read and understood the Important Notice.