Global credit offers deep bond universe

Developed credit markets, such as Europe and the US, continue to remain liquid with more than $9trn (£6.8trn) of bonds outstanding. However, yields in both markets have declined significantly, with European investment-grade credit offering investors an average yield of only 1.2 per cent.

This number masks the €100bn (£83.6bn) of European corporates that are already trading with a negative yield.

Asian credit is facing the opposite problem. Yields are still attractive, with almost 3 per cent on offer for investment-grade securities, but there are fewer bonds available than in developed markets ($440bn in Asia), with a similar trend seen in high-yield markets.

The European high-yield market yields an average of 4.4 per cent, whereas the Asian equivalent pays investors around 7.4 per cent. This is an attractive return potential for Asian credit.

Traditionally, investors have tended to focus on their home markets and only reluctantly invest globally. This unwillingness derives mainly from a lack of research experience in global credit markets and perceived additional risks, such as the currency risk investors face outside their domestic markets.

Investing globally can assist fixed income investors by adding extra alpha sources to their toolbox. Interest and credit cycles are not synchronised globally, which often leads to different outcomes in different regions.

For example, last year the US high-yield market lost more than 4 per cent, while Asian high-yield bonds gained more than 4 per cent. Therefore, choosing the right market and balancing exposure across markets can make a significant difference to portfolio performance.

The best-performing regions for credit so far this year have been the US and Latin America John Vail, Nikko Asset Management

In addition, less liquid but higher yielding markets can offer attractive inefficiencies, which skilled research teams can translate into attractive trade ideas. Liquid markets offer fewer of these types of opportunities.

Besides the performance potential that can be gained from global investing, the risk-management implications should not be overlooked. Regional strategies often suffer from concentration risk, which can be easily observed in the Latin American credit universe, with its focus on energy-related issuers.

Usually, default risks should be manageable for experienced analysts; nevertheless, it is important to avoid complacency in portfolio construction with too much exposure to individual issuers. Global credit offers a broad pool of opportunities with almost 1,500 issuers and offers investors the opportunity to construct granular portfolios without unintended concentration risk.

In the first five months of 2016, global credit performance has been positive. The down-trend in global interest rates, driven by further quantitative easing and the dovish messages of major central banks, has provided significant support to the market.

The European Central Bank and the Bank of Japan even went a step further by committing not only to buying government and agency bonds, but corporate bonds as well.

There have also been fundamental changes, such as the recovery in commodity prices, that have helped the resources and energy sectors improve. Additionally, lower rated, high-yield bonds delivered solid returns in the global credit segment.

The best-performing regions for credit so far this year have been the US and Latin America. For the rest of the year, positive sentiment towards global credit is expected to prevail. Credit fundamentals are expected to remain stable, while interest rates and credit spreads should be anchored by central banks (at least in Europe and Japan).

Although default rates are rising, the problem is mostly related to energy issuers and shouldn’t affect the rest of the universe, particularly Europe where credit quality is still improving. For example, over the past 12 months, Moody’s has upgraded more high-yield issuers than it downgraded.

The current challenge facing most fixed income investors is balancing these dual needs of earning sufficient returns and keeping a portfolio liquid, to allow repositioning if necessary.

Opening up fixed income portfolios to the broad universe of global bond issuers can help investors meet these challenges. A judiciously invested global credit portfolio should offer sufficient return potential to meet most clients’ expectations, while addressing the liquidity and risk-management implications of investing.

John Vail is global strategist at Nikko Asset Management