Fraser Lundie, co-head of Credit at Hermes Investment Management, explains why security section is a crucial element of his investment approach.
We look at credit in a different way to the majority of our peer group. Within the credit world, there is a sense that if you get the company right and avoid default you will have done your job as a bond investor. While this is a neat premise, we believe it is a gross oversimplification of the asset class.
By only focusing on the quality of a company you have only dealt with the equity risk – not the fixed income risk. You haven’t tackled convexity, duration, illiquidity or volatility by getting the company right.
For us, it is crucial to drill down deeper and get the security right within the company. Hence, we will do our bottom-up analysis like everybody else, but as important for us is – what is the most appropriate risk-adjusted way of accessing that company’s risk?
Is it through bonds, loan or CDS? Is it through dollars, euros or sterling? Is it through three-year, ten-year or 30-year issues? By emphasizing this part of the decision making process, we think investors can mitigate the fixed income risk attached to the company.
For example, if we look at the gold sector, we prefer issuers that are positioned lower on the cost curve, are less exposed to geopolitical risk and have demonstrated a strong track record amid lower gold prices. Taking these factors into account, we believe Barrick Gold is the most attractive opportunity in the sector.
However, when we analyse a company, we like to apply a different lens and look at the capital structure from a bondholder’s perspective. In the case of Barrick Gold, it is attractive due to its liquid capital structure which includes a CDS contract.