A leading fixed income fund manager at Pictet says it is crucial to avoid some biases traditionally commonly found when investing in the asset class, but which markets have ‘acted in defiance of' recently.
Sagayam welcomes moves to central clearing and electronic exchange of CDS in the US as aiding both transparency and liquidity there. He would also welcome regulation of CDS, such as short selling restrictions, but only if they “took out people truly abusing the market and causing enormous prices moves on some days”.
He notes here, though, hedge funds account for only 7% of all CDS trading, “and the end-user demand for CDS is now so widespread”.
On emerging markets, Sagayam’s team is positive generally, but involved selectively.
He points to some cross-border opportunities, for example involving Chinese oil and gas companies, versus credits in Brazil, South Africa and Indonesia, where “too much euphoria has been built in following local currency inflows and the opportunity is to be short risk. Some of the more open economies – Australia and Malaysia, for example – may be affected in the event of a China slowdown given their export-dependencies.”
He says from a sovereign debt perspective “the good times are over”. Treasury holders, for example, face 10 year yields below 1.6% and risk losing one third on capital if yields revert to their 50-year average.
“Once you factor in inflation, you are talking about negative real returns and this cannot be ignored. For government bonds, the question is whether you are willing to have your money tied up for 10 years for such low yields.
“Here you must make a distinction between credit risk premium and all-in yield. The latter are very low because the risk-free rates are being kept very low through QE and loose monetary policies. Whenever we come into credit risk, we have immunized the interest rate risk and we may even profit if yields rise, particularly in certain regions.”
At a macro level Sagayam says there is a real possibility of decisive policy action in Europe due to current concerns about Spain. Any bail-in of banks would “not be done for free and that could compromise subordinated financial credits and may spill over into senior credit.
“We are starting to put trades on [financial] senior subordinated debt particularly in Italy and Spain and are also looking carefully at the relationship between covered bonds and senior CDS protection in certain cases, which could profit from this outcome.”
Sagayam adds it helps when running the fund to do so jointly with someone he has worked with for 11 years – and with reciprocal trust. “These are challenging times in the markets, and our investors benefit from the filter of two people looking at the same world and sectors, and agreeing on a trade before implementing it. In doing so, we believe this improves the risk-adjusted profile of the fund as a whole.”