Richard Kendall and Nicola Marinelli of Glendevon King Asset Management believe big is not necessarily beautiful when it comes to fixed income fund management.
Most of Glendevon's clients are based in Europe, a region where it has become increasingly difficult to generate sizeable returns over the past 18 months. While there are plenty of good companies to choose from, even in the periphery, market technicals have often worked against investors due to heightened sovereign risk. Glendevon's Northern Exposure strategy, which focuses on the relatively stable Nordic countries, was born out of the demand from clients to separate company risk from country risk.
"You might like a company in Portugal, for example, but find that performance suffers because of the country risk," says Marinelli. "You could try and hedge the sovereign risk, but if you are long-only you cannot enter into derivatives contracts. The idea behind the Northern Exposure fund was to find countries where there is little sovereign risk: Denmark, Finland, Sweden and Norway fit into that category. The latter two have a lot of mining and oil-related companies; shipping, technology and agricultural companies. While the market is smaller than the euro market, you can get diversification. If the investment goes bad, it is because you were wrong on the company, but at least it won't be because something negative happened with the government."
From high to low
One market Marinelli is less positive on is high yield, which has enjoyed two years of stellar returns. But while defaults are at all-time lows in the high yield space, Marinelli insists current valuations are not justified, with his view largely based on a belief that economic cycles, and by extension default cycles, are getting shorter.
"The default cycle is at the bottom, and the expectation is that it is going to stay there for a while, but once it is at the bottom it can only go up. Over the cycle, investing in single-B companies currently yielding 7% or less is going to cost you money. Now it is a carry trade, and as long as conditions are good it will pay off, but when things start to turn for the worse - and they will - investors could easily lose all the carry they have benefited from this year," says Marinelli.
For an investment house with a focus on finding discounted opportunities, 2009 was a particularly favourable vintage as asset prices began to recover from their crisis lows. Even last year, there were good opportunities to be found, particularly in subordinated debt issued by financials. But with spreads tightening across all asset classes, mudlarking for bond bargains is proving altogether more difficult in 2011.
"We are waiting for an opportunistic situation, like the BP crisis last year, where something bad happens and the bonds become cheap, even though the long-term prospects for the company are compelling. I now have the highest level of cash since the fund started, because it is very difficult to find things that make sense in terms of risk/return. We are all looking for a little bit of weakness, so that new issues come at wider levels and we can put money to work again. But credit spreads are not really widening: there is no negativity, and a lot of people are sitting on a lot of cash," says Marinelli.
The current tight spread levels across credit asset classes almost seem anomalous given the heightened sense of macro risk in Europe. Marinelli agrees with the suggestion that the credit markets are close to being "priced to perfection", but says this has little to do with bond investors suddenly being bullish.
"In the fixed income and credit space, people are aware of the risks out there, but nevertheless, we have not yet seen the trigger for a big widening in spreads. Even when the Eurozone situation periodically worsens, the Crossover index only moves from 350 to 360 basis points. When I traded Crossover in 2008, 10bp was the bid/offer spread: the index itself often moved by 100bp or more intraday. So volatility now is very low, and people do not want to get too short because they fear a little bit of good news will push the index tighter and they'll have to pay the carry."