Hunting for yield in alternative credit

Added 27th March 2017

Record-low bond yields have sent both institutional and retail investors in search of alternative credit options for their portfolios. They have tried absolute return funds, mainly with underwhelming results. Some are therefore proving their luck elsewhere in the fixed income spectrum.

Hunting for yield in alternative credit

hunting

Large institutional investors have started to move from government bonds to areas such as infrastructure debt, mortgages and direct loans. But most professional investors are yet to follow suit.

José Luis Borges, head of institutional portfolios at BPI Gestao de Activos in Lisbon, explains: “We have no allocation, neither do we plan to invest in alternative fixed income. We have strict liquidity requirements and are not very familiar with it.”

A ‘better the devil you know’ approach may be sensible but the long-term risk/return prospects for core fixed-income holdings are so poor that investors need to diversify away from the high interest rate risk that low-yielding government bonds bring.

Loans are probably closest to traditional, listed fixed income.

“Loans as an investment case are quite similar to high-yield bonds but they offer a cleaner credit risk exposure,” says Mikkel Sckerl, portfolio manager of a loans fund at Capital Four AM, a Copenhagen-based boutique asset manager with €10bn in AUM.

"With Libor now above 1%, investors can finally benefit from the floating rate component in loans. Any further increase in Libor would be a net positive" - Omar Gadsby

“The loan maturity is typically six to seven years, which is similar to high-yield bonds but loans don’t have call protection and are typically being repaid after three to four years,” Sckerl says. “Loans typically never trade much above par but are a pure income-clipping instrument. They are not about capital appreciation.”  

Since loans are always senior-secured, they have a higher recovery rate than high-yield bonds, of which only about a quarter are senior-secured, but they also come with a coupon that is 150-200bps lower. All this results in direct loans showing a stable return profile with a low correlation to other asset classes.

Sckerl’s fund has an annualised return of 5.47% since inception in December 2014, significantly trailing the average return of a high-yield bond fund over that period. But the risk/return characteristics of his fund are excellent: in the listed bond space, it is hard to find a fund with a Sharpe Ratio above three, as his fund has. 

On the upside

Omar Gadsby, head of fixed-income fund selection at Credit Suisse Private Banking, is also a fan of loans. He finds them especially attractive now as US three-month Libor has risen to an eight-year high.

“During the majority of the post-crisis period, Libor has been very low, and to make senior loans attractive to high-yield investors, issuers had to implement Libor floors of 90bps [a minimal interest guarantee].

“With Libor now at 1.04%, investors can finally benefit from the floating rate component. Any further increase in Libor would be a net positive [compared with high-yield bonds, which is a fixed-rate investment].”

Article continues on the next page 

Inside the Expert Investor - March 2017 Issue

Expert Investor - March 2017

The March issue of Expert Investor magazine is now available to read online. View your digital edition by clicking on the link below, or download the free Expert Investor App through your app store. 

CLICK HERE TO GET YOUR ISSUE

Inside this month's edition:

  • Analysis of the options available to investors in the alternative credit space; from loans to microfinance.
  • Folksam Fondforsäkring’s head of fund selection Susanne Bolin-Gärtner, one of the few prominent women in the profession, talks about her shift of focus from specialised to flexible funds;
  • Gary Collins, head of European fund distribution at Columbia Threadneedle, discusses how he is coping with the pressure to reduce fees.
  • Explaination as to why investors should look at currency risk from more than one angle

Expert Investor is available in the iTunes App StoreGoogle Play and on Kindle Fire. To see how you can access your digital magazine click here

Visitor's Comments Add your comment

Add Your Comment

We won't publish your address

Features

Hunting for yield in alternative credit

Hunting for yield in alternative credit

Record-low bond yields have sent both institutional and retail investors in search of alternative credit options for their portfolios. They have tried absolute return funds,...

Interviews

Ricardo Libano & the active/passive dilemma

Ricardo Libano & the active/passive dilemma

Ricardo Libano, a fund selector at the Portuguese wealth manager IM Gestão de Ativos in Lisbon, has a natural inclination to invest in active funds. But it’s not always easy...

About Author

Tjibbe Hoekstra

Senior Reporter

Tjibbe joined Expert Investor as a senior reporter in March 2014. Before moving to London he worked as a financial news reporter for various news outlets in Amsterdam, including Reuters and ANP, the main news agency in the Netherlands. He also worked for Fondsnieuws, a website and magazine for finance professionals in the Netherlands. Tjibbe holds a MSc in Public Administration and a post-graduate diploma in Journalism.

Top Stories

ANALYSIS: Brexit one year on

ANALYSIS: Brexit one year on

It has now been exactly a year since the UK electorate made, as a British fund manager put it recently, “a huge strategic error of the like the country hasn’t experienced in maybe a century”...

Emerging market bond inflows – just starting or topping off?
Emerging market bond inflows – just starting or topping off?

Has the run into emerging market bonds only just started, or have flows already reached saturation...

Wells Fargo AM launches European IG credit fund amid challenging outlook
Wells Fargo AM launches European IG credit fund amid challenging outlook

Wells Fargo Asset Management isn’t afraid of a challenge. It has launched a European investment...

News

What next after China A-share MSCI inclusion?

What next after China A-share MSCI inclusion?

Wealth and asset managers give their views on the implications of the MSCI inclusion...

Published : 22, Jun 2017

Saudi Arabia closes in on emerging market status as royals reshuffle

Saudi Arabia closes in on emerging market status as royals reshuffle

Saudi Arabia has taken a big step towards being classified as an emerging market...

Published : 22, Jun 2017

China A-share inclusion a small first step

China A-share inclusion a small first step

Largely within expectations, the MSCI will add Chinese A-shares to its emerging markets...

Published : 21, Jun 2017

Investors remain hungry for value stocks

Investors remain hungry for value stocks

European value stocks have been in high demand with investors, who are banking on...

Published : 20, Jun 2017

ANALYSIS: What to watch out for as Brexit negotiations begin

ANALYSIS: What to watch out for as Brexit negotiations begin

“Positive and constructive” was how the UK’s Brexit secretary David Davis described...

Published : 19, Jun 2017

Events

Expert Investor Congress Spain 2017
Expert Investor Congress Spain 2017

Monday 25 & Tuesday 26 September
Melia Hotel, Valencia

Expert Investor Italy 2017
Expert Investor Italy 2017

Tuesday 3rd October 

Hotel Principe di Savoia, Milan

Expert Investor Sweden - Equity 2017
Expert Investor Sweden - Equity 2017

Wednesday 11 October
Grand Hotel, Stockholm

Expert Investor Alternative UCITS 2017
Expert Investor Alternative UCITS 2017

Thursday 19 October
Grand Hotel Huis ter Duin, Noordwijk

OTHER STORIES FROM LAST WORD...