Lionel Pernias (pictured), Head of Buy and Maintain Strategies London at AXA Investment Managers, writes on the key themes he is observing at the moment.
Q: Please tell me a little about AXA IM.
A: AXA Investment Managers (AXA IM) is an active, long-term, global, multi-asset investor. We work with clients today to provide the solutions they need to help build a better tomorrow for their investments, while creating a positive change for the world in which we all live. With approximately EUR747 billion in assets under management as at end of March 2017, AXA IM employs over 2,450 employees around the world and operates out of 29 offices across 21 countries. AXA IM is part of the AXA Group, a world leader in financial protection and wealth management.
AXA IM has more than 20 years heritage as a ‘buy and maintain’ (B&M) investor in the UK, and one of the longest fund track records in the market. One of the funds managed by AXA IM’s ‘buy and maintain’ team is the AXA Sterling Buy and Maintain Credit Fund which launched five years ago. The fund offers investors access to a product specifically designed for today’s challenging market conditions, aiming to combine the best of both active and passive approaches at a low cost. The strategy aims to help mitigate the impact of structural changes in the corporate bond market and its aim is to provide an income and capital return in line with the broad sterling market. The fund is about creating diversified credit portfolios and capturing the Beta of the Sterling credit market. This means moving away from tactical trading and adopting a low turnover approach. The Fund has experienced zero defaults, and only a fraction of the downgrades to sub-investment grade than the broad Sterling Credit universe (the BofA ML Sterling Non-Gilt Index).
Q: What are the key themes facing investment grade credit strategies at the moment?
A: We remain of the view that there are no imminent signs of the credit cycle coming to an end. The macro outlook is supportive and recent strength in corporate earnings growth has reduced the tendency for leverage ratios to increase. Fundamentals and technical factors, on the whole, are supportive for credit markets. The exception is the UK where political uncertainty may introduce more volatility into financial markets.
Spreads have been more or less stable in recent months and we expect that to continue with exposure to investment grade credit benefitting from a lack of volatility. In mixed portfolios this means there is good reason to hold exposure to IG, especially in the US where the yields/spreads are more attractive.
In Europe, the technical picture remains positive with the ECB still buying for now and net issuance likely to be limited. IG remains a rock solid asset class, with the US market likely to produce the better returns given the higher carry.
In addition, one trend we’ve seen over the past several years, both Smart Beta strategies and responsible investment (RI) have garnered increasing attention from investors across the globe – first in the equity space, and now also in the credit space. Though seemingly unrelated, both trends signal a move by investors away from unintentional and often uncompensated risks associated with traditional index-tracking strategies. Investors are also increasingly recognising the importance of environmental, social and governance (ESG) factors in creating long-term value.
Given today’s challenging credit markets, we believe the tandem rise of Smart Beta strategies and responsible investment signals a move by investors away from unintentional risks associated with traditional index-tracking strategies — revealing a greater willingness to make their own determinations about desired exposures, risks and expected returns. By constructing a fully integrated ESG B&M credit portfolio, we believe that Smart Beta and responsible investment are not only compatible but actually enrich each other, as judged by our representative portfolio characteristics and ESG profile.
Q: How do you manage liquidity in a portfolio of this type?
A: Lower liquidity, higher transaction costs and historically low yields have forced a rethink of credit strategies. Traditional market capitalisation-weighted credit indices present imbalances in terms of lack of diversification at the issuer, sector and country levels, creating systemic as well as issuer-specific risks. The reasons for this are obvious: using market capitalisation to build an index means allocating the highest proportion of assets to borrowers or sectors that have the most public debt outstanding, perversely rewarding issuers that take on greater amounts of debt and subjecting investors to an unduly high amount of credit risk.
B&M’s philosophy counted on efficient long-term beta capturing. Investors quickly backed this strategy which explicitly addresses the fundamental flaws of traditional credit indices. The overall aim of our B&M credit philosophy is to harvest the maximum amount of yield from the investment grade credit markets on a long-term basis with potentially lower downside risks owing to the combination of better regional, sector and issuer diversification, superior fundamental credit research and a B&M, low turnover approach.
Q: What key trends and opportunities are emerging for 2017?
A: Little has changed in the macro outlook recently. Global growth is solid and has broadened. Purchasing manager surveys show continued expansion in both manufacturing and services sectors. World GDP growth is expected to be 3.3 per cent this year and slightly stronger in 2018. Inflation remains subdued and the recent fall in oil prices will likely mean that headline inflation rates remain soft.
As a result monetary tightening is a slow-moving theme. The market has largely priced out most of the expected Federal Reserve (Fed) rate increases and the US yield curve has flattened. This reduces long duration opportunities in the US curve although the level of yields is still relatively attractive. In general, we remain negative on government bonds but in the short term we expect core markets to remain in well-established trading ranges.
In addition, the benign macro outlook and reduced political risk should support the continued preference for higher yielding assets within fixed income. Our preferred sectors are high yield, emerging markets and structured credit. However, valuations are expensive on most metrics, especially in core liquid markets.
It’s also worth noting that risk premiums offer less reward than they did at the beginning of the year. Yields curves have flattened (lower term premium), inflation break-evens are lower, credit and quality spreads have narrowed. Investors get less reward for taking interest rate, inflation and credit risk. Largely this reflects strong liquidity in global markets and low volatility given the support from very low interest rates. This regime is expected to persist over the summer. However, on a medium-term view higher yields and wider spreads are expected. As such, fixed income retains an option to position very defensively should there be signs of volatility picking up over the summer months.
