It is understandable why many investors are cautious: if a BBB rated bond gets downgraded it moves from the investment grade category to high yield or ‘junk’ status and with many portfolios restricted to holding only investment grade, the market impact of downgrades can be significant.
With a muted global growth outlook putting increased pressure on issuing companies, investors are right to be cautious.
However, we believe a selective approach to investing in the BBB universe can reap rewards for investors.
We see a significant amount of flexibility in a range of well-run BBB rated companies in terms of the steps they can take to maintain a BBB rating in the event of harder economic times.
Examples include companies like AT&T and Anheuser Busch, which have launched debt-friendly initiatives like reducing share buybacks and — in extreme cases — reduced dividends or disposed of non-core assets.
Many investors have also overlooked corporate hybrid securities – bonds which combine features of debt and equity securities. The expected payoff profile – available upside return versus potential downside risk – of this part of the market is attractive, yet it has lagged year-to-date relative to other areas of the credit market which are perhaps overextended, such as US high yield.
In this vein, dynamism and selectivity are as vital for avoiding the more susceptible areas of the credit market as they are for capturing overlooked potential.
Swimming against the tide of mainstream investors through a carefully plotted route can bring significant enhancements to both the risk and return side of the equation, in our view.
The benefits of a freestyle approach
An unconstrained investment approach gives credit investors access to a broader opportunity set and affords them greater flexibility to adapt to changes in credit risk premia and market technicals across different areas.
We believe this approach is best placed to deliver the full risk-adjusted return potential of credit markets in the year ahead.
By increasing the flexibility to seek the best investment opportunities across the global credit universe while avoiding susceptible segments, an unconstrained strategy can provide a diversified portfolio which aims to be high-yielding yet comparatively defensive.
Investors wishing to navigate the credit world would do well to choose a sturdy yet nimble vehicle rather than hop on the same boat as the rest of the crowd.
Garland Hansmann and Jeff Boswell are managers of the Investec Global Total Return Credit fund