Interest rates have started to head south again and investors are bracing themselves for another bout of late-cycle volatility.
If the US Federal Reserve continues to cut interest rates, the current cycle’s peak – a mere 2.5% – will be the lowest since the federal funds rate was first introduced in 1954. And while the injection of liquidity appears to have calmed markets, uncertainty about the length and outcome of the US-China trade war is likely to cause turbulence.
A flexible approach can help investors access the most attractive parts of the credit spectrum in this low-yield environment. Investors can search credit classes and capital structures to invest in the most attractive instruments with conviction and establish defensive positions amid the constant threat of volatility.
The returns of flexible-credit funds have drivers across geographies, sectors and instruments, which allows investors to access an increasingly globalised credit market. In a world where the global stock of negative-yielding bonds stands at $17tn, investors need access to a variety of instruments to capture income.
Flexibility can also help investors achieve downside protection during periods of instability and reduced liquidity. Unconstrained strategies can preserve capital by allocating to less risky parts of the market, or using defensive option-based strategies during sell-offs, enabling them to take advantage of opportunities when valuations inevitably become distressed.
A flexible approach adds value more consistently. While high-yield funds have the potential to generate larger returns, flexible bond funds have made more frequent gains and delivered positive returns in a greater number of periods over the past decade.
All-weather approach
Last year’s sell-off prompted issuers to take creditor-friendly actions and cut dividends and sell assets. The dispersion of spreads among instruments has increased, and we see opportunities for active managers to seek alpha by distinguishing between lower-rated issuers and mid-quality companies that have taken steps to preserve capital.
The outlook is uncertain, but a flexible approach will help investors identify and capture the opportunities that exist late in the cycle.
At Hermes, we look for opportunities across the global credit spectrum, targeting attractive returns throughout market cycles while preserving capital. Security selection is important and it involves searching the capital structures of issuers for attractive instruments. Our large-cap bias helps us access better liquidity, while persistent emphasis on downside protection means we are able to find opportunities when markets are fearful.
There are four main aspects to Hermes’ approach to credit investing:
Allocation
Unconstrained, global investing across credit sectors, industries, ratings and liquidity profiles throughout market cycles.
Conviction
Through high-conviction, relative-value security selection within the capital structures of issuers, we seek attractive income and capital returns in all market conditions. Proprietary ESG analysis and company engagement strengthen our views.
Downside protection
By preserving capital during market sell-offs, defensive options strategies also help to protect the ability to take risk when the opportunities are greatest. Dynamic management of rates and credit duration also aims to safeguard portfolios.
True to mandate
Vigilant of commitments and responsibilities to investors, we aim to prevent style drift and abide agreed risk parameters.
For more information on Hermes Flexible Credit, click here.
