At GAM Investments’ Weekly Investment Meeting held on 19 June 2019 the speaker was Anthony Smouha, who provided an insight into the rallying subordinated debt market.
Developed Market Credit
While we can look back on a very robust start to the year, we believe this performance, in part, reflects the sharp price declines witnessed in 2018 despite the absence of defaults. Consequently, we effectively remain in a cheap phase of the market cycle and, even when this year’s gains are taken into account, we still believe we are at an attractive entry point. Given that security prices are only beginning to catch up, we have seen a lot of attractive bonds issued as junior credits offering elevated income streams. This favourable market backdrop permits investors to purchase paper with little apparent risk at extremely high yields. Meanwhile, we believe the ‘Draghi effect’ (expectations of even looser monetary policy) is likely to underpin the recovery trend in prices, although they are unlikely to go up in a straight line.
From a performance perspective, the subordinated debt of insurance companies and the AT1 CoCos (contingent, convertible securities) of banks have performed particularly well in the calendar year to date. We feel these securities are very attractive but it is important to bear in mind that this is a singular and special segment of the credit universe, and the older legacy bonds where we also hold a significant weighting also remain attractive. In terms of valuation, the spreads on the AT1 CoCos of major banks are especially attractive at around 480 bps on average, providing a very significant extra yield. New issuance is also attractive, with the latest Barclays AT1 CoCo offering a yield close to 8%, which equates to a spread of 650 bps. The issue was five times oversubscribed but the securities are already trading at prices north of 102p. With a lot of the usual participants holding cash on the sidelines, we expect the market to be well supported in the months ahead.
In addition, we also favour floating rate notes (FRNs) even though they have significantly lower running yields andhave underperformed in the ‘hunt for yield’ scenario we are currently witnessing. This is because such paper offers protection when rates are rising and some of it is trading very cheaply. As such, we believe there is a strong case for continuing to hold it in a well diversified developed market credit portfolio as it should not detract from the overall high and attractive yield.
In summary, the market has enjoyed a strong start to 2019 and, given hints of softer monetary policy ahead, we expect the recovery to continue, even if not in a straight line.
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Source: GAM unless otherwise stated.
The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development. Reference to a security is not a recommendation to buy or sell that security.