Credit valuations favour investors, says AXA’s James Gledhill
James Gledhill, global head of High Yield at AXA Investment Managers and manager of the AXA Global High Income Fund, says that investors are being paid well for taking on credit risk.
Following a very strong 2012, we entered 2013 with reasonable rather than cheap valuations for high yield. On an absolute basis looking at yields, yields are now low in historic terms. However on a relative basis versus government bonds spreads remain pretty wide and defaults are far below average. Investors are being well paid for taking credit risk and we are comfortable that default rates will not increase in the near-term.
US vs Europe
When looking at allocations to the US and Europe there are many things to bear in mind, including valuations, liquidity and the macro environment/ headline risk, which has become a much more important consideration than it was in the years before the financial crisis. There is now more tail risk and as such, the macro needs to be taken into account when picking bonds, along with the micro credit risk analysis.
Looking at the macro, the US is in much better but not brilliant shape compared to Europe and there are signs that the US is returning to growth. This improving picture means that we are beginning to see the return of risk taking in the US market. It is still early days and not as yet a concern, but leverage is beginning to pick up and with this we are also starting to see more event risk associated with M+A activity, LBOs etc. Most European companies remain in a ‘bunker mentality’ with a continued focus on strengthening balance sheets and remaining very cautious. This means that defaults are less of a concern that you might expect as they are prepared for the difficult macro environment. The average credit quality of the market in Europe is better than in the US. Although the two markets optically yield about the same, when you adjust for the credit quality difference, European yields are around 80bps higher than in the US which seems fair.
A bar bell approach
While the macro environment is more important than pre-crisis, stock picking remains at the heart of our approach and our focus is on credit risk. In the AXA Global High Income Fund (the Fund) we are overweight short duration credit compared to the market and our competitors*. We like this area of the market because while you get a lower return, you also get much lower risk and hence a good sharpe ratio. We are also overweight the 9%+ of the high yield market – effectively this is B- rated credit as well as some CCC+. This is the riskier end of the market but, importantly, we are not targeting the riskiest. This approach means that the Fund has a duration of around 3 years compared to about 3.6 for the overall universe, but this is a happy outcome of us managing credit risk rather than being driven by avoiding interest rate risk
The Fund is diversified across the global high yield universe. We are fundamentally stock pickers, but sectors we like are for example, services as it is very uncorrelated with other sectors and these companies also tend to have a low capital intensity so can service their debt.
It is hard to overstate the importance of central bank behaviour to the valuation of financial assets. Globally, the focus remains on trying to stimulate economic growth through monetary policy while fiscal policy is aimed at reducing government deficits. This means that official interest rates should remain low for a long time and asset market pricing will continue to be largely driven by Quantitative Easing (QE). We believe that global high yield spreads remain attractive versus government bonds and that spreads provide an attractive compensation for default risk, versus underlying government bond returns.