ChampionsNews: Mr. Blaabjerg, you set focus on high yield and emerging markets bonds in your investment process. Since bond markets are generally less efficient and liquid, how do you obtain constant returns with your strategy?
Blaabjerg: Constant returns are hard to obtain for any asset class, which is not a bank deposit. But we do apply some common sense initiatives in our portfolio management to limit the size of potential drawdowns. So, we are not buying CCC or distressed credits even though they are part of our benchmark. We want low default activity in our portfolios and actively search the market for corporate bonds that are issued by companies, which have a proven track record and not too much debt on the balance sheet. We also underweight countries with similar distressed characteristics – we have no exposure to Argentina as an example.
ChampionsNews: In times of low interest rates high yield bonds and emerging market bonds are a valid alternative to achieve proper returns. What are the main advantages of both asset classes compared with classic bond investments (corporate/sovereigns)?
Compared to classic bond investments high yield bonds and Emerging Markets corporate bonds offer a yield pick-upKlaus Blaabjerg
Blaabjerg: Compared to classic bond investments high yield bonds and Emerging Markets corporate bonds offer a yield pick-up, which serves as a buffer against rising interest rates. So, the correlation of high yield bonds and Emerging Markets corporate bonds with classic bond investments is pretty low. From a portfolio perspective this is very interesting as high yield bonds and Emerging Markets corporate bonds according to standard portfolio theory would then serve to enhance expected return for any given level of risk if added to a portfolio of just classic bonds and equities.
ChampionsNews: Which high yield and emerging market bonds have been successful investments in the last six to twelve months in both your funds? Please name at least two examples with investment explanation.
Blaabjerg: Some of the best performing corporate bonds in our two funds ABSALON – Global High Yield (ISIN LU1138630212 / LU1138630139 ) and ABSALON – EM Corporate Debt (ISIN LU1138630998 / LU1138630725 ) are related to the energy sector. We hold a bond from Noble Holding International, which is a drilling company supporting oil and gas production. This bond has made a return of more than ten percent year to date. Because of the large price appreciation this bond has moved a lot closer to our fair value target and we have taken profit. Another example is Enquest PLC, which is an oil production and development company. The bonds from Enquest PLC have made a return of more than 20 percent year to date but they are still cheap. The reason for holding these two bonds have been attractive risk reward profiles – falling debt levels, a focus on further debt reduction alongside high credit spreads.
ChampionsNews: High yield bonds are often questioned due to the unsteady liquidity and high volatility. It is often said that once the ECB lowers its Quantitative Easing high yield bond market could be under major pressure. Do you agree with this opinion? Are investors scared uncalled-for?
Blaabjerg: To be honest I am asking myself the same question. My reflections on this difficult question goes like this: European credit spreads have already underperformed US credit spreads a lot year to date, despite lower default activity in Europe than in US and despite more conservative management behaviour among European companies regarding credit quality, and hence future default activity. I believe financial markets are forward looking and that they already have discounted less quantitative easing from the ECB to some degree. Some people might argue that a complete stop of Quantitative Easing by the ECB is not fully discounted by the markets yet. To this I would reply that current credit spreads are already too high compared to the expected level of defaults.
ChampionsNews: What are your expectations for the high yield and emerging market bond market in the next six to twelve months?
Blaabjerg: For the global High Yield market our default model points to a default rate of around two percent. If we then use a conservative estimate of 25 percent for the recovery rate we get an expected loss from defaults over the next twelve months of around 1,5 percent. The Euro hedged yield of our global high yield fund is currently 5.75 percent. Hence without counting on any spread tightening I would expect our global high yield portfolio to yield a return of 4.25 percent. I think it is more difficult in today’s market to have a very strong return estimate of Emerging Market assets, since there are some hot spots around – for example Argentina, China, Turkey, Brazil because of elections and Russia regarding sanctions. I do think we have a very strong Emerging Markets corporate portfolio though and I would be surprised to see an even higher return than 4.25 percent for this portfolio. The likelihood of this happening would of course increase dramatically without Mr. Trump!
Author: Klaus Blaabjerg and Timo Lüllau
Date of issue: 9/25/2018
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