Challenging Times Pose Unique Opportunities for Shared Services
Challenging trends and opportunities in corporate bonds
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Transcript of Challenging trends and opportunities in corporate bonds
Challenging trends and opportunities in corporate bonds
6Stricter rules,
new solutions
12A smarter way to
harvest factor premiums
4The liquidity pitfall
of passive investing
14ESG integration,
in particular for
corporate bonds
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The Robeco approach for credits 2
Challenging trends and opportunities in corporate bonds 3
The liquidity pitfall of passive investing 4
Stricter rules, new solutions 6
Flexible strategies to benefit from relative value trade-offs 8
More diversification with emerging economies 10
A smarter way to harvest factor premiums 12
ESG integration, in particular for corporate bonds 14
Contents
Further information
W www.robeco.com/credits
2 | Challenging trends and opportunities in corporate bonds
The Robeco approach for credits
The team follows its own research, not public opinion or the general
consensus. “We always aim to act contrarily in our portfolios,” says
Sander Bus, head of the credit team.
Macro approach for beta positioningGlobal trends are an important element in the investment approach.
These are analyzed every quarter, as external specialists such as brokers
and strategists discuss specific market themes together with our analysts
and portfolio managers in order to assess the risks and opportunities in
the credit market. This top-down macro approach forms the input for
the desired beta positioning of the portfolios. Victor Verberk, co-head of
the credit team: “Understanding the global macro economic environment
is essential to understanding our investment category.”
Sector focus for knowledge advantageThe Robeco credit team consists of 27 portfolio managers, credit
analysts, researchers and traders. The team invests globally and applies
an integrated approach for investment grade, high yield and emerging
credits strategies. This approach is unique. Analysts have a sector
responsibility irrespective of grade or country of origin. After all, sector
developments are global and therefore should be monitored and analyzed
from a global perspective. This approach gives the analysts
a knowledge advantage and gives the team the possibility to capitalize
on the inefficiencies that occur as a result of existing market
segmentations. The credit analysts in the team are all very experienced
in their sector. They are offered the possibility to advance their careers
within their disciplines and to rise above their international peers with
their expertise and seniority.
Sustainability research, integral part of issuer selectionEach analysis is carried out according to a predefined framework. Issuers
are analyzed based on five components, i.e. company strategy, company
position, financial profile, company structure and sustainability criteria.
With regard to sustainability, the analyst analyzes the downside risk
resulting from poor scores on Environmental, Social and Governance
factors. The sustainability analysis is thus an integrated part of our credit
research.
The Robeco credit team manages approximately EUR 21 billion in
various funds and mandates as of the end of April 2014. Assets under
management have increased by approximately 25% a year since 2008.
Robeco’s credit team has an investment style that focuses on thorough research, on which every investment
is based. We believe that the management of a corporate bond portfolio is not about selecting a few of the
best bonds, it is about avoiding the losers in a well-diversified portfolio. This generates alpha.
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Challenging trends and opportunities in corporate bonds
Corporate bond markets are in a constant state of flux and continue to
present new challenges to us as asset managers. In addition to the usual
market cycles for investment categories, the bond market is also subject
to structural changes. Not only asset managers and their clients are being
confronted with this, it is also relevant for institutional investors with their
obligations to pensioners and policy holders.
In this magazine we identify a number of market trends, which we believe
are relevant for our clients. We will specifically discuss the challenges that
these trends pose, and more importantly, how we think our clients can
capitalize on these trends.
Changing market conditions can limit the effectiveness of passive investingStricter risk regulations for liquidity providers (banks and brokers) have
structurally changed market conditions. We argue why active managers
are better equipped to capitalize on market liquidity than passive fund
managers.
Stricter rules, new solutionsWe increasingly see that supervisory bodies are tightening the rules on
the financial markets. Examples are Basel III for banks and Solvency II for
insurance companies. As a result, all market players are being confronted
with new questions, but equally important, certainly also with interesting
new investment opportunities.
Flexible strategies benefit from relative value trade-offsFlexible integrated credit strategies are emerging. These strategies can
benefit from making relative value trade-offs to switch between credit
segments. Traditionally, institutional investors tend to select specific
managers for each segment, which can be a disadvantage in today’s
markets. We explain the rationale and the drivers behind the benefits of
flexible integrated strategies.
More diversification with emerging economiesInvestors’ horizons will expand further in the coming years. On the
one hand, information analysis will become more complex due to the
convergence of developed and emerging economies; on the other hand,
this development offers new diversification possibilities for investors.
We believe that an increasing strategic portfolio allocation to ‘new
economies’ will be an important theme in the coming years. We will
discuss our expectations regarding the growing importance of emerging
credits.
Factor investing within creditsWithin Robeco, research has been the basis for every investment since we
first began in 1929. Quantitative research based on market anomalies has
led to the successful introduction of a new type of investment products
based on factor investing. Our ‘conservative’ strategies are based on what
is known as the ‘low-risk’ anomaly. This approach is already known from
equity investments; however, our research has shown that this anomaly
also exists in credits.
More sustainability information results in better investment decisionsAnother important issue for companies and investors is how to deal with
sustainability. Increasingly companies in which we invest are focusing on
sustainability and reporting on this. Investors who are able to interpret
this information correctly and translate this into risks and opportunities
have an information advantage. In this publication, we discuss how to
incorporate sustainable investing and how Robeco integrates this in the
investment process, and we also correct a number of misconceptions
regarding sustainable investing.
I hope you will enjoy reading this publication and I would like to invite
you to enter into a dialog with us about the challenges that we face as
investors in corporate bonds.
Edith Siermann
Chief Investment Officer Fixed Income
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4 | Challenging trends and opportunities in corporate bonds
Decreasing liquidity is changing the marketIn recent years, investors in corporate bonds have been confronted with
decreasing market liquidity. This is mainly attributable to the changed
attitude of investment banks. Banks have become more cautious due
to the financial crisis and have therefore reduced their corporate bond
trading activities. In addition, banks are maintaining higher capital ratios
because of stricter regulations. They trade less often for their own account
and focus mainly on bringing buyers and sellers together.
Patrick Houweling, senior quantitative researcher and fund manager of
the Robeco Quant High Yield Fund, concludes that the reduced liquidity
could cause problems for investors in passive funds. “The credit market
has grown significantly in recent years, also because of the increased
popularity of ETFs. In normal market conditions, ETFs can be traded quite
easily. However, when markets turn and corporate bonds go out of favor,
investors can be unpleasantly surprised. Passive funds typically mirror
their underlying index. As a consequence the fund managers must sell
and buy certain bonds regardless of market conditions. When adverse
market conditions prevail and a large number of investors wish to sell
bonds without finding enough buyers to match supply, this may cause
the investments in the ETFS that are based on full replication to be sold
considerably below their net asset value. This applies mainly in turbulent
markets.”
The liquidity pitfall of passive investing
Investing in ETFs can be very risky, especially during periods of limited liquidity.
Patrick Houweling and Victor Verberk explain why and how active management and
the use of derivatives can provide both a solution and an investment opportunity.
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Premium/discount Market Price Net Asset Value
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Uncertainty about Greece brought the price of the high yield tracker below the net asset value
Active management avoids crowding at the exitVictor Verberk, co-head of the credit team, says that when investors opt
for active management they will no longer have to worry about executing
orders in unfavorable market conditions and avoid crowding at the exit.
“Managers of actively managed funds have various buttons that they can
press. First of all, as a fund manager you can seek to profit from market
movements. It is often unwise to sell during periods of market stress.
Markets often overreact. This is mainly due to parties such as ETFs that
are obliged to replicate their benchmark. Active management allows you
to capitalize on this situation. If you would like to reduce the size of your
portfolio, you can use that moment to sell less attractive bonds and – vice
versa – if you are enlarging your portfolio you can buy additional expected
outperformers. You must have the courage to trade contrarily. As an active
investor, you can thus profit from forced buying and selling by passive
funds. In fact, you can collect the premium that they need to pay.”
‘As an active portfolio manager, you have more buttons that you can press’
‘In turbulent markets, ETFs are sometimes sold far below their net asset value’Houweling illustrates this with an example: “Corporate bonds were under
pressure in May 2012 due to the uncertainty about Greece. The market
price of a corporate bond fund normally lies above its net asset value.
However during that period, the market price of the iShares-tracker in
European high-yield bonds was up to 89 basis points lower than its net
asset value. The reverse is true as well as this could also work the other
way around when passive fund managers need to buy in buoyant markets
conditions. In that case, they will pay too much for the bonds they need to
replicate their index. This occurred in July 2012.”
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Challenging trends and opportunities in corporate bonds | 5
“A second advantage of active management is that you can maintain a
somewhat larger cash position. A lack of liquidity in the market is not a
problem if you do not necessarily have to sell or buy immediately. The
cash position makes this possible. Furthermore, you can reinvest the cash
in bonds that are liquid at any moment.”
According to Verberk, the third button which the fund manager can press
is the composition of the portfolio. “Actively managed funds can deviate
from the chosen benchmark. Not only does this provide flexibility, it can
also lead to an advantage in stressful markets. In June 2013, when there
was unrest in connection with the Fed policy, we were able to sell triple-A
asset backed securities relatively easily.
Finally, you can also make use of credit derivatives in the portfolios. These
are generally more liquid than bonds issued by the same company.”
Making use of liquid credit derivativesHouweling has recently been appointed manager of a fund that
predominantly invests in credit derivatives. “The Robeco Quant High Yield
Fund is a very liquid solution to invest in credits. The portfolio consists
of credit default swap (CDS) indexes, which are much more liquid than
individual corporate bonds. This is very appealing from a risk perspective.
Due to the absence of an illiquidity premium, CDS indexes suffer much
less in bear markets. Another advantage is that CDS have a ‘bullet
structure’. This means that, unlike many high yield bonds, they cannot be
redeemed in advance. This is a positive feature for the return potential of
CDS.”
“Because of the high liquidity of the CDS indexes, you can actively
and cheaply position the portfolio to profit from market trends. The
fund uses a proven quantitative model, which we have used now for
many years, to vary the beta of the fund between 0.5 and 1.5. Such a
quantitative investment style offers diversification for investors in addition
to fundamentally managed funds. Moreover, the fund is interesting for
investors with a tactical investment view. For these investors, who would
like to implement their investment view actively, the large degree of
liquidity and the low costs are very favorable.”
Houweling concludes that liquidity in the corporate bond market does
not have to be a problem. “Active management and the use of derivatives
offer both a solution and an investment opportunity.”
‘With CDS indexes, you can profit from market trends at lower costs’
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6 | Challenging trends and opportunities in corporate bonds
Basel III Basel III, which came into force on 1 January 2014, obliges banks to
have higher levels of core capital, specifically Common Equity ‘Tier-1’.
The expectation is that banks’ capital buffers will increase further in the
coming five years.
The stress test for EU banks has raised the bar significantly. The European
Banking Authority on April 29, 2014 said banks will need to show they
have enough capital to be able to survive a worst-case scenario. This
entails: a 7% drop in GDP, a 14% fall in house prices and a 19% decline in
equity prices. These are far more stringent criteria than those of the 2011
stress test, which only allowed for a 0.5% fall in GDP. The real economic
contraction in the recession that followed was higher than that.
“The stress test seems to be fairly harsh, but we do not expect that there
will be many banks with capital shortfalls. We think that most banks which
had potential problems have issued equity already,” says Jan Willem
Stricter rules, new solutions
Increased regulation for banks and insurers, implemented in the wake of the financial crisis, is changing
the landscape for pension funds and other professional investors. But Basel III and Solvency II also present
opportunities in fixed income, particularly in the shape of new hybrid bonds and low-volatility credits.
de Moor, portfolio manager of the Robeco Financial Institutions Bonds
fund. “So we expect that the confidence in the banking sector will further
increase because of the stress test.”
Basel III forms part of a wider banking union and the introduction of the
Single Supervisory Mechanism, where the European Central Bank will
take over bank supervision from November 2014 onwards. The banking
union envisages a common EU policy, a single pan-European supervisory
mechanism, a deposit guarantee scheme and a resolution mechanism
that would recapitalize or liquidate failing banks in a structured way.
Basel III is providing interesting investment opportunities related to
financial sector credits. In future, existing ‘old style’ Tier 1 bonds will
no longer comply with the Basel III regulations. These will therefore be
replaced by a new type of bond (additional Tier 1) which offers a bank
more safety options if they get into trouble. Several hundreds of billions
of euros in new bonds are expected to be issued in the coming years. This
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will replace existing Tier 1 bonds once they reach their call date. Banks are
also expected to continue issuing subordinated Tier 2 paper for general
funding. This will offer huge investment opportunities.
In the early stage of bank refinancing, capital was created in the form of
‘contingent convertibles’, or CoCos. The CoCo element can be added to
Tier 2 bonds or even senior bonds. CoCos have a trigger mechanism for
emergency measures dependent on the bank’s core capital level falling
beyond a specific level. Banks may then skip coupon payments to save
money – which means investors run the risk of losing interest income – or
convert the bonds into equity. The bond could also be wholly or partially
written off. As these bonds are riskier and more complex than traditional
bonds, a higher level of investment expertise is necessary.
“We buy CoCos if we think that the capital reserves are sufficient and if
there is only a very, very small chance that the bank’s core capital will
reach the trigger level. The risk of conversion is then considered a tail
risk,” says De Moor. “We look at the quality of the banks as well as the
bond’s specific characteristics, including the trigger for potential write-
downs or coupon deferral. In addition we consider the bank’s business
profile, to see how volatile their earnings are likely to be.”
Solvency II When Solvency II comes into effect, insurers will also need to have higher
capital buffers against the risks they run. The slow legislative process
in finalizing the framework’s details has led to its implementation date
being postponed until at least January 2016, but most insurers have
already taken the necessary steps in anticipation of these changes.
Insurers will be obliged by Solvency II to hold enough capital to cover
the risk of their investments, while they also try to raise returns for
policyholders. The Catch-22 problem here is that yields on safe sovereign
bonds are at historical lows, requiring investors to look at higher-yielding
products such as credits. This raises the risk profile of their holdings
requiring more capital to act as a buffer.
Robeco’s Conservative Credits strategy is based on the ‘low-risk anomaly’:
over the long term lower-risk bonds have consistently performed better
than bonds with higher risks. This means that the Sharpe ratios of low-risk
bonds have been consistently higher.
Solvency II capital requirements have been calibrated on historical
volatilities, which implies that a Conservative Credits portfolio not only
delivers superior returns per unit of risk, but also per unit of Solvency II
capital.
“Solvency II looks as if it could have been designed for Conservative
Credits. Insurers can use it to invest in a strategy with low risk and less
Solvency II capital, while generally being able to earn the needed returns
for their clients,” says portfolio manager Patrick Houweling.
“The strategy is perfectly situated between AAA-rated government bonds,
which are very safe but offer low yields, and general credits, with higher
yields but also substantially higher risks.”
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8 | Challenging trends and opportunities in corporate bonds
Benefits from a flexible, integrated approachMost institutional investors allocate capital to specific asset classes,
segments, sub-categories and then specific managers. For credits this
includes segments such as high yield or investment grade, or sub-
segments such as Asset Backed Securities (ABS) or covered bonds.
It has been a modus operandi for decades, but this kind of ‘box-ticking
exercise’ remains an inflexible approach. Now a trend has emerged to use
flexible strategies which can allocate more freely, and are more diversified
and globalized. Essentially, such a fund-building exercise benefits from
being able to access all available opportunities across various credit
segments.
This is more flexible than a traditional approach where changing
allocations may require a new manager selection process, extra red tape
and transaction costs. At the same time, institutional investors should
be mindful about the cost effectiveness of flexible integrated strategies
as well, since excessive switching between credit segments will also be
expensive.
Flexible strategies to benefit from relative value trade-offsNew flexible credit strategies offer institutional investors market segmentation benefits through one integrated
approach. This article explains the benefits and the rationale.
When using this flexible integrated approach, it becomes possible to look
for relative value trade-offs within the whole credit universe, for instance
in using ABS instruments versus covered bonds, or high yield subordinate
securities versus investment grade paper. The goal of making the right
relative value trade-offs is to achieve higher returns via a broader set of
opportunities.
What are the main drivers behind this trend? Victor Verberk, head
of investment grade credits at Robeco, highlights three underlying
rationales.
Rationale 1: Desynchronized cyclesThe flexibility of an integrated credit strategy is increasingly required as
central bank policies continue to desynchronize and as different credit
markets reprice securities as their economies and companies improve at
different rates. Desynchronized cycles lead to dispersed monetary policies
and different interest rate environments across the globe, making it
increasingly important to avoid a local bias.
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Desynchronization has led to opportunities to switch between the
traditionally separated developed and emerging credit markets.
The current compressed difference between high yield and investment
grade offers fewer opportunities.
“As we are now quite late in the credit cycle, bonds are becoming more
expensive and sometimes more rate sensitive”, says Victor Verberk. ”It’s
now ideal to be able to jump between segments and not be constrained
by boundaries.”
“For example, in the last 12 months emerging credits have significantly
underperformed developed markets because rate fears from the Fed have
been prevalent since June 2013. And now, developed markets may start
underperforming.”
“So if you are flexible and not restricted by segmentation strategies you
can switch from developed to emerging markets, where many corporate
bonds are now repricing. Or, if you anticipate that the Fed will increase
interest rates much sooner and more aggressively than the market
expects, you can switch into government bonds or ABS, which can
outperform unsecured credit.”
You can also benefit from desynchronization if you take a wider, more
integrated view, he says. “For a few years investors were long Europe
versus the US and that worked perfectly well at the time. Now, due to
rate risks, the US credit market will become more volatile. Emerging
markets have already repriced, and that makes global positioning more
important.”
Rationale 2: Changing perceptions of riskVerberk says one problem with continuing the traditional allocation by
institutional investors is that perceptions of risk have changed since the
financial crisis of 2008-09, and some bonds that appear ‘safe’ have
become much more expensive, making quality risk-adjusted returns
harder to come by.
“If everything is over-compressed in certain areas, then it looks safe, but
it is expensive and can be misleading,” he says. “A high yield bond with
a spread of 1,000 basis points over a sovereign bond can be safer than
something that is 300 basis points over. You need the expertise to know
what is really worth owning.”
Many institutional investors still provide mandates that require a strict
split between all these segments. What can make matters worse is that
regulators sometimes press for even less flexibility within mandates. This
ensures that flexible, integrated funds will retain their benefits for the
years to come.
Rationale 3: Benchmark disadvantages Another problem with the traditional allocation towards specific segments
in combination with very specific benchmarks is that there is a greater
chance they will include high risk securities an investor may want to avoid,
such as unhealthy banks. “The smaller your universe is, the more you
become obliged to invest in anything that’s in the index, and your chance
of having bad luck with exposure to a company with a very high default
risk is bigger,” says Verberk. “With a global view it is easier to find the best
ideas.”
Robeco’s new Global Credits fundRobeco’s new Global Credits fund offers the flexibility of an
integrated strategy. The fund invests in the best-of-class credits
across all asset classes regardless of type or location, and does
not follow a benchmark. Since the Robeco credit team has
a composite record, there is a three-year track record available
for a similar strategy as the one for the new fund.
To make such a global strategy work, a large and experienced
team is required to be able to pool individual specialties and
enable the fund manager to get the best of all worlds under
one roof. “We have a big credit team now of more than twenty
people including expertise in emerging credits, high yield,
investment grade and secured finance within one integrated
team. It is ideally equipped to come up with all the best ideas in
all the market segmentations,” says Verberk who is the portfolio
manager of this fund.
Verberk serves on many of Robeco’s 500 credit committees,
getting the best possible overview of all segments and regions.
“It means I can go across the teams and see everyone’s ideas. If
for example there is a credit that is BB and is about to cross over
into investment grade, one of the team members can spot it and
alert me. I do the same for coming fallen angels for the high yield
specialists. It is a flexible approach for a flexible strategy,” he says.
This lack of bias is used to investors’ full advantage. “The
biggest benefit of being global is the ability to have global ideas
generation,” says Verberk. “The breadth of our ideas is bigger as
the global market is almost endless and there is always a good
risk/return out there.”
“We typically have a research driven investment process with a
somewhat longer investment horizon. The overwhelming amount
of ideas comes from our own research. This way trading costs are
limited. We prefer old-fashioned bonds with a prospectus and no
counterparty issues, to derivatives. However, for short positions or
overlay strategies, derivatives are very efficient.”
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10 | Challenging trends and opportunities in corporate bonds
Increasing financing requirementDue to a significant increase in prosperity and more social security in
emerging markets, households have started to consume more and
make use of credit. This often concerns short-term loans, for example, to
purchase household goods or a car. However, a market for mortgages and
long-term loans is also starting to arise. In order to ensure that the supply
increases in line with the demand for goods and services, companies
have been investing in production capacity, infrastructure and real estate.
Consequently, a structural increase has also occurred in the demand for
loans among companies in recent years.
This rapid growth of corporate loans and consumer loans has caused
the total debt of emerging countries to be more evenly spread between
the private and public sector as the debt of the public sector has grown
a lot less rapidly. These economic developments have stimulated the
development of capital markets.
More diversification with emerging economies
The beginning of the 21st century was characterized by a strong increase in global trade, relocation of
production from developed to emerging countries and an unprecedented demand for natural resources.
This resulted in a period of more than ten years of uninterrupted economic growth in emerging countries.
Capital markets for emerging markets are rapidly maturingPrior to 2000, the governments of emerging countries could practically
only borrow in hard currencies such as the dollar or the euro. As a result
of the increased stability in the past years, investors are now more often
willing to lend to governments in local currencies.
The emergence of a market for corporate bonds is the next step. The
market for corporate bonds from emerging countries is developing
extremely fast. The market has grown in the past five years from USD 340
billion to more than USD 1.4 trillion today . This investment category is
thus already bigger than, for example, the US high yield market.
The credit market was initially dominated by large state-owned
companies in specific sectors such as oil and gas or banks. However,
more diversification has occurred in recent years with companies for
the consumer sectors such as IT or retail. The trend in creditworthiness
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has also been positive. In 2014, approximately 70 percent of the issuing
companies has an investment grade rating.
The dynamics of emerging creditsDue to an unprecedented availability of international capital and the
growing demand for loans, more and more companies are seeing the
advantages of establishing long-term relationships with investors.
Companies are increasingly willing to adapt their reporting standards and
governance to the wishes of western investors in order to obtain access to
international capital.
As a result of the rapidly growing number of ‘new’ companies, the
emerging credit market is under-researched. This provides many
opportunities for investors. The fact that this segment is under-
researched, also provides extra opportunities for active managers such
as Robeco, to prove their added value by realizing outperformance.
However, there is also another side to the coin. Not all companies are
fundamentally healthy and, in some cases, investors are insufficiently
protected. This demands a new approach. Not only the company or the
country itself must be carefully analyzed. The influence of a country on a
company and the importance of a company for a country are particularly
relevant criteria. On the one hand, for instance, government intervention,
corruption or legislation can impact a company. On the other hand,
there is the importance of a company as, for example, a country’s energy
supplier. By comparing companies worldwide within a sector and taking
the country risk into account in the analysis, the quality of each company
can be placed in a clearer perspective.
1 Source: JP Morgan Emerging Markets Reference Presentation March 2014
Opportunities for institutional investorsCorporate bonds from emerging countries offer the possibility to obtain
direct access to themes such as ‘the emerging consumer’ without the
volatility of equities or currencies. Moreover, this new market offers
the possibility to increase the diversification in an investment portfolio.
Economic cycles in emerging countries often differ from the cycles in
Europe and the United States. In addition, this market offers a large
number of new companies to invest in. Therefore, it is not surprising that
investors are becoming increasingly interested in this market. In 2011,
Robeco decided to build up expertise in corporate bonds from emerging
economies in addition to its emerging equities strategies
Robeco Emerging CreditsRobeco manages the Robeco Emerging Credits fund based on a
total-return approach. This is a fund that focuses specifically on
corporate bonds from emerging countries. Of course, we also
offer institutional investors the possibility to participate in this
rapidly developing investment category via a mandate structure.
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12 | Challenging trends and opportunities in corporate bonds
A smarter way to harvest factor premiums
Scientific research1 in equity markets shows that investing based on factors
results in an improvement of the Sharpe ratio of portfolios in the long
term. Well-known factors are Low-risk (low-volatility stocks), Value (stocks
with a low price/book ratio), Momentum (stocks with a high return over
the past twelve months) and Size (small companies). These factors are
also referred to as anomalies because their returns cannot be explained
with traditional investment theories. Research carried out at the request
of the Norwegian Government Pension Fund showed that the largest part
of the active return of this fund could retrospectively be attributed to the
exposures to these factors.
Better Sharpe RatioBasing its approach on factor investing in equities, Robeco carried out
research into the construction of corporate bond portfolios using the
following factors: Value, Momentum, Size and Low-risk. Martin Martens,
Head Quantitative Fixed Income Research at Robeco: “Our research
shows that investing based on factors results in a better Sharpe ratio
than investing in the whole market index. This applies to both investment
grade and high yield. So factor investing indeed works for credits.” This is
illustrated in the figure below.
According to Patrick Houweling, Quantitative Credits portfolio manager
and researcher, the challenge is to use a definition for each factor that
Factor investing is often only associated with equities. Scientific research shows that focusing on the characteristics (‘factors’)
of equities results in an improvement of the risk-adjusted return. However it is less well known that factor investing also
works for credit portfolios. Our research in credit markets shows that investing based on factors results in a better Sharpe
ratio than investing in the market index.
1 See also: Fama & French (1992), “The Cross-Section of Expected Stock Returns,” The Journal of Finance; Jegadeesh & Titman (1993), “Returns to
Buying Winners and Selling Losers: Implications for Stock Market Efficiency,” The Journal of Finance; en Blitz & Van Vliet (2007), “The Volatility Effect:
Lower Risk without Lower Return,” The Journal of Portfolio Management.
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Market Value MomentumInvestment Grade
Size Low Risk Market Value MomentumHigh Yield
Size Low Risk
Generic definitions Smart definitions
Sharpe ratio factors
is specific for credits and not to just ‘simply’ copy the equities definition.
“For example, the objective for Value is to determine whether a
company’s credit spread is too high or too low and not whether the shares
are expensive or cheap. For ‘credits Value’, the trade-off is generally
between the market estimate of the risk - the credit spread - and the
objective risk as for example estimated by a rating agency. Another
example: for the low-risk factor for equities historical volatility is often
used. For credits, the maturity and the rating are generally regarded as
generic risk measures: the longer the maturity and the lower the rating,
the riskier the bond.
Smarter definitionsIn addition to a generic definition of each factor, Robeco also uses a
‘smarter definition’. Robeco examined whether the Sharpe ratio of the
general definition could be improved by estimating risks more precisely
or avoiding unnecessary risks. Martens: “For Value, instead of looking
at ratings, you can look at theoretical credit risk models that combine a
company’s balance sheet information, such as leverage, and a company’s
equity information, such as its volatility, in a smart way.” Houweling: “You
can construct a low-risk portfolio by avoiding the longest maturities and
the worst ratings. This already results in a better Sharpe ratio than the
market. However, we have found smarter risk measures than ratings. Our
study shows that a better Sharpe ratio can be achieved for each factor
than with the generic definition.”
Low-risk creditsAnalogously to low-risk equity investing, Robeco developed a strategy two
and a half years ago for low-risk corporate bond portfolios. Houweling:
“Our empirical research shows that, in a full investment cycle, low-risk
corporate bonds have the same return as ordinary corporate bonds,
but with a 50% lower volatility. This results in a better Sharpe ratio.
The key is that you implement the low-risk factor by investing in low-
risk bonds of low-risk companies.” Martens lists three rules of thumb
for the implementation: avoid unnecessary risks, do not go against
other anomalies and avoid unnecessary turnover. Martens: “Avoiding
losers is more important than selecting winners. In addition, you can
decrease risks by constructing a diversified portfolio. Do not select Source: Robeco
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Challenging trends and opportunities in corporate bonds | 13
companies only based on Low-risk characteristics, but also make use of
Value and Momentum. And finally, opt for a buy and hold strategy to
avoid unnecessary turnover and high transaction costs, and to earn the
illiquidity premium.
Fundamental checkIn addition to quantitative analysis, fundamental analysis by the Credit
Team is also important in order to monitor non-quantifiable risks that are
difficult to capture in a model. What does the structure of the company
look like? Has the parent company issued a guarantee for the entity that
issued the bond? Did the management announce a planned acquisition
that will result in higher leverage? How does a company score on ESG
criteria, such as sustainability, labor conditions and the quality of the
management? Houweling: “These types of risks are not reflected in the
existing balance sheet data. Our analysts identify the non-quantifiable
risks timely and thus help further reduce the risk of the portfolio.”
Robeco Conservative Credits Within Robeco Conservative Credits, the low-risk factor is
implemented by investing in a disciplined manner in low-risk
bonds of low-risk companies. Conservative Credits is being
applied in various mandates with a total size of EUR 2.6 billion as
at the end of April 2014. Robeco is currently carrying out research
into the implementation of other factors in disciplined strategies.
For more information visit www.Robeco.com/conservative-credits
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14 | Challenging trends and opportunities in corporate bonds
ESG integration, in particular for corporate bonds
As an illustration: there are simply no longer any Requests for Proposal
without questions about ESG (environment, social and governance). And
the assets that are managed by organizations that have signed the UN
Principles for Responsible Investment (PRI) have risen from USD 4 trillion
at the introduction in 2006 to USD 34 trillion in 2014. This represents 15%
of global assets available for investment. In addition, the signatories of
the PRI have to comply with increasingly strict requirements.
The many interpretations of sustainabilityThere is general consensus now on the fact that sustainable investing is
not simply a hype that is going to blow over. Although most institutional
investors no longer regard this as a ‘green’ or ‘ethical’ strategy, there are
still a large number of interpretations and implementations, varying from
excluding weapons manufacturers to a way to manage long-term risks.
Robeco helps pension funds to develop their convictions, ambitions and
policy in the field of sustainability. In addition, we implement this policy
by integrating sustainable investing in the existing investment policy or by
offering voting and engagement services. We can also screen portfolios
on sustainability and provide a detailed report on this.
The integration of sustainability in credit investmentsRobeco applies complete integration of ESG factors in all credit strategies.
Besides a company’s competitive position, strategy, financial position and
structure, ESG is one of the five pillars of the credit analysis. We do this
because we are convinced that ESG factors provide additional relevant
information so that we are better able to analyze a company and to limit
the downward risk of investment portfolios. The weight of the ESG pillar
in the total analysis depends on how financially material this is. There are
a large number of ESG indicators for each company and we only analyze
the ESG aspects that are the most relevant for the company’s financial
position and profitability.
Institutional investors are becoming increasingly aware of the fact that trends such as population growth, the scarcity of raw
materials and globalization have an impact on a company’s risks and opportunities. Under the pressure of regulators and investors,
such as participants in pension funds, sustainable investing is slowly but surely evolving from a ‘niche’ to a general trend.
‘There is general consensus now on the fact that sustainable investing is not simply a hype that is going to blow over’
Focus on limiting riskThe Corporate Sustainability Assessment (CSA), or the sustainability
scores of RobecoSAM, Robeco’s sustainable investing subsidiary, is based
on surveys held among approximately 2800 companies and plays an
important role in the credit process. These scores are discussed by the
credit team with the specialized RobecoSAM sustainability analysts. We
mainly focus on negative elements such as weak spots in the corporate
governance or in the environmental policy. In addition, we supplement
our research with other sources that can expose even more risks. For
example, we scan the media to see if the company is involved in legal
proceedings or settlements. After all, the amounts involved in issues like
this can have a substantial impact on the company’s financial position.
Is sustainable investing expensive?At Robeco, we look at ESG from a financial perspective. Return is the most
important issue for us. It is a myth that ESG integration is at the expense
of return. Many questions in RobecoSAM’s CSA concern financially
material issues such as governance, risk management, personnel policy
and other factors that ultimately also affect a company’s profitability. ESG
analysis enables us to take better informed decisions and to pick up risk
signals in an early stage. This way, we are able to avoid the losers.
Unique: an active dialog with credit issuersAnd we go a step further than just analysis. A team of engagement
specialists enters into an active dialog - engagement - with selected
companies about financially important themes that are determined
in consultation with portfolio managers, investment analysts and
sustainability analysts. That this not only takes place for equities but also
for credits is unique. We encourage companies to take concrete steps
to improve their sustainability, as this also has a positive effect on their
creditworthiness.
An example is our engagement with the Brazilian energy company
Petrobras. Petrobras subsidizes gas prices by purchasing at the market
price and selling under the market price. As a result, the company
has a large influence on the inflation rate. The chairman of the board
of Petrobras is also the Brazilian Minister of Finance and therefore
the company’s independence is doubtful. Together with a number of
institutional investors and in cooperation with our credit analysts, our
engagement analysts proposed two independent members of the Board.
This proposal was approved by the shareholders, which has resulted in a
considerable improvement in the company’s corporate governance.
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Challenging trends and opportunities in corporate bonds | 15
Exclusion also excludes improvementIt is exactly because we believe in a constructive dialog that we
only exclude companies if there is no other option, for example, if
they structurally violate the principles of the UN Global Compact or
manufacture controversial weapons. The most important objection to
exclusions – especially exclusions on the basis of conduct – is that as
an investor you then deny yourself the opportunity to exert a positive
influence on the operations of the company in question. We believe in
long-term relationships with companies – a positive approach in which
we try to convince a company that improvement is also in its own interest.
Moreover, we are convinced that a company that has an answer to today’s
challenges in the field of the environment, society and good governance,
offers better prospects and entails fewer risks and is therefore more
attractive for credit investors.
‘A company that has an answer to today’s challenges in the field of the environment, people and good governance, is more attractive for credit investors’
‘It is a myth that ESG integration is at the expense of return’
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16 | Challenging trends and opportunities in corporate bonds1138_E-08’14
Important informationRobeco Institutional Asset Management B.V. (trade register number: 24123167) is licensed by the Netherlands Authority for the Financial Markets (AFM)
in Amsterdam. The Spanish branch Robeco Institutional Asset Management B.V., Sucursal en España is licensed by the Spanish Authority for the Financial
Markets (CNMV) under register number 24. All funds in this publication are UCITS and authorized for the commercialization in France by the AMF. Any
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investors only.
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The information contained is only intended for the addressee and must not be forwarded without the prior consent of Robeco.
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This material has been prepared by Robeco Institutional Asset Management B.V. for informational purposes, should not be considered as a solicitation
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