Investors need to stop confusing credit with bonds, according to Investec’s Garland Hansmann (pictured), who says these asset classes are frequently lumped in together even though they contain instruments that often move in opposite direction
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The long-term outlook for government bonds is poor, with yields at such low levels they have little room to fall further. Yet investors often extend this generalisation to fixed income as a whole, which also applies to the credit market – predominantly made up of corporate bonds.
Hansmann, who runs the Investec Global Total Return Credit fund, said this is a mistake as although the main risk with government bonds is rising interest rates, in corporate bonds it is the risk of defaulting on a loan.
“Imagine a scenario where inflation goes up,” he said. “Is that good for government bonds? No, government bonds will go down. Is that good for credit? It depends. If it is investment-grade, then it is probably bad.
“But if it’s a high yield company, it’s good. Why? Because the inflation that underlies the business of that company will help to boost earnings and those earnings will facilitate a quicker and more secure pay-off of the loan that you’ve extended to them.
“And that is the point. So, you can see that fixed income has undergone two different things. But mentally, people don’t think of it that way.”
The aim of Investec Global Total Return Credit is to fill a gap in the non-equity side of a portfolio, delivering a return of Libor plus 4 percentage points a year while keeping volatility low. Hansmann said this is only possible in credit markets if you take a genuinely active approach.
“If you look at it segment by segment, there are always some segments in the current market which do really quite well," he added.
"And so as long as you’re in the right segments at the right point in time, you can actually make that return that investors need.
Discrete calendar year performance of credit market sectors
Source: Investec Asset Management
“If you have a portfolio that just statically invests across the different credit markets, it is not going to get you there.
“But if we go to the original strategy, you will see that the portfolio has had massive shifts in a short time frame. So, we think this is something that is truly, truly active. And the reason for that is that it doesn’t even have a benchmark, it’s really just trying to achieve a return.”
Changing sector exposure in portfolio since launch
The main reason investors hold government bonds is as a hedge against a recession and subsequent equity market crash. Credit would not work as well in such a scenario, while high yield, which accounts for more than 30 per cent of Investec Global Total Return Credit, would do particularly badly.
Hansmann said that while the probability of a recession is as high as it has been for some time, he does not think an occurrence would be anywhere near as bad for high yield as it was in 2008, for example.
“One of the consequences of this low interest rate environment is that central banks have very little room to manoeuvre,” he continued.
“So, in our mind, they can talk a tough game now if they want to, but if the numbers deteriorate, they’re going to be stepping on the gas as quickly as possible again. In a way, this very low-yield environment takes out the cyclicality of the economy a lot more than in a higher-yielding environment, simply because the central bank has to act earlier.
“That means this concept of recession in the sense of a big GDP decline doesn’t seem that big of a risk to me. We potentially have a technical recession where growth is slightly below zero for two consecutive quarters. That’s very conceivable. Is that an environment that is really bad for credit? No, that’s an environment that’s bad for equity.”
Hansmann admitted that the fund would not be able to achieve its long-term outcome in a “horrific GDP meltdown situation” in which there were continuous and widespread defaults. However, he said such a situation was “almost inconceivable”.
What the manager said would be more likely was another equity market correction or an uptick in interest rates, which would send government bond prices tumbling. However, he said his fund would be relatively unaffected in such situations.
“So [the fund] doesn’t have that interest rate exposure, it doesn’t have that susceptibility to economic downturns the way an equity fund would, but it still gets you to that level of pleasure,” he concluded.
“It sits in that sweet spot that the pension funds discovered four, five or six years ago, but the retail investors have not. And the story today in my mind is, why not?”
Data from FE Analytics shows Investec Global Total Return Credit has made 4.86 per cent since launch in May 2018, compared with gains of 7 per cent from the IA Sterling Strategic Bond sector.
Performance of fund vs sector since launch
Source: FE Analytics
The £170m fund has ongoing charges of 0.87 per cent and is yielding 3.13 per cent.