Joseph Portera
Ken Hill
In fact, the challenge has become even more complex. More than 10 years into the longest economic expansion in U.S. history, we are, to use a baseball analogy, already in extra innings. The Federal Reserve appears committed to extending the cycle as long as it can, but when the final out is recorded and the economy slips into a recession—or is hurdled into one by an exogenous shock—financial markets will likely take a hit. Even as they search for yield, then, many CIOs are also looking for ways to preserve capital.
It’s a narrow tightrope, and navigating it may require a repositioning of fixed-income portfolios. After all, a decade of extraordinarily low yields has induced in many portfolios a slow but persistent “risk creep.” Simply put, with little in the way of yield available from the higher credit-quality segments of the market, many investment managers have taken on significantly more risk in a bid to boost returns.
Concurrent with the long slump in interest rates, there also has been a general deterioration in the overall quality of the U.S. corporate investment-grade debt market. Exposure to BBB-rated credits in the Bloomberg Barclays U.S. Corporate Index has ballooned more than 25% over the past 30 years, for example, and now represents approximately 50% of the benchmark, up from 24% in 1999[1].
A smart way forward
For many CIOs, an active multi-sector credit strategy could offer a smart way forward in this challenging environment.
As the name implies, active multi-sector credit strategies invest in multiple sectors of the fixed-income markets. They employ active rather than passive management, recognizing that different sectors of the fixed-income markets don’t always move in lockstep and may, at any point in time, have significantly different risk profiles. A multi-sector credit strategy seeks to take advantage of market variations by shifting between different market sectors as risks change and opportunities present themselves. Because this is being done by a single manager, it may be possible for these shifts to be executed more nimbly, and at lower cost, than they would if an asset owner had multiple managers each running their own portfolios dedicated to individual segments of the market.
At Invesco, our multi-sector credit strategy invests across four major sectors of the fixed-income markets: global high yield, bank loans, emerging market debt, and global investment grade. We employ both top-down and bottom-up research to position the portfolio opportunistically, driven by changes in the economy, market direction, and fundamental security analysis. We retain the flexibility to place different weightings on these factors at different stages of the credit cycle. Our overarching goal is to provide returns approaching those achieved in the high-yield market while exposing the portfolio to significantly less risk.
From its inception in October 2013 through year-end 2018, this strategy had a better Sharpe ratio than the Bloomberg Barclays Global High Yield Corporate USD Hedged index in 89% of all rolling three-year periods, while closely tracking high-yield returns. For the entire time period, Invesco’s multi-sector credit strategy delivered an average annual total return of 3.86% with an average Sharpe ratio of 1.05, versus a return of 4.21% and a Sharpe ratio of 0.77 for the index. The maximum drawdown for the strategy over this period was -4.21%, versus -8.12% for the index.[2]
Past performance is no guarantee of future results, of course. But we believe active multi-sector credit, overseen by a single manager with expertise in all core sectors of the fixed-income markets, offers a number of potential benefits for CIOs looking to boost returns without taking the full level of risk associated with high-yield fixed income. It can make particular sense for investors who don’t have the bandwidth to run such a strategy in-house, or who have an institutional structure and investment process that makes it difficult, under a traditional multiple-manager approach, to move between asset classes quickly enough to take tactical advantage of market changes. Indeed, we see a substantial amount of money moving out of high yield strategies and into multi-sector credit. The inflow is coming not only from U.S.-domiciled pension plans but also from wealth managers at large banks, Japanese pension plans and European insurers. These diverse entities share a common desire—to earn an above-nominal fixed-income coupon while preserving capital.
Invesco’s approach to multi-sector credit is designed to seek consistent and strong risk-adjusted returns in the face of market ups and downs. It is not an absolute return product, however. We rarely move outside of credit to gain value through currency or rates. While our strategy has drawdowns, our structure and management approach help to minimize them—especially late in the credit cycle. And it can be tweaked at any time in the cycle to add or subtract risk.
In fact, we have recently taken steps to insulate, protect and preserve capital in our multi-sector credit portfolios over the next six to nine months. Heading into the year, we had increased risk fairly substantially within our guidelines. Believing the Fed had gone too far too fast in increasing interest rates, we were comfortable with more duration exposure. Among other things, we took some opportunistic long positions in BBB and CCC credits, the former of which worked out fairly well, the latter not so much. Over the course of the year we’ve since been working that risk down.
We’ve also been exploring opportunities in the bank loan sector. After paring our loan holdings in the third quarter of last year, when spreads between bank loans and high-yield securities had narrowed, we added some exposure back, using derivatives, at the start of the year. We reduced our exposure again in the middle of the second quarter, and have since started layering it back on in response to changing market conditions. Overall, we believe high yield is fully valued, and that a lot of good news is already priced into that sector regarding Fed rate cuts. Accordingly, we think bank loans will perform at least in line with high yield, or perhaps even outperform it, over the next two to three quarters.
The flexibility to make on-the-fly tactical adjustments like these is rooted in the nature of our process. Within the four pillar asset classes in which we invest, the portfolio can be tilted to take on or reduce risk. Tactical allocation bands allow managers to further position a portfolio opportunistically, within minimum and maximum limits for each asset class.
The good news for CIOs is that while a multi-sector credit strategy is well positioned to navigate through the late stages of a credit or economic cycle, it is truly a full-cycle strategy, eliminating any worries about when to take advantage of it. At Invesco, for example, our multi-sector credit managers aren’t equally weighing sectors based on market value. Rather, we calculate the percent of market value that would give each sector an equal contribution to risk. Similarly, we don’t focus on overall strategy duration, unless it becomes important for capital preservation. And our managers know that they’re never going to invest in a name solely because it’s a big part of a benchmark. Their goal—our goal—is not to mimic an index, but to deliver the best income and capital appreciation opportunities within each asset class.
For CIOs looking to navigate what could be turbulent markets ahead, we think that’s an approach worth considering.
This article is for US Institutional Investor Use Only. Content was developed in November 2019. This is for informational purposes only and is not an offer to buy or sell any financial instruments. As with all investments there are associated inherent risks. This should not be considered a recommendation to purchase any investment product. Please obtain and review all financial material carefully before investing. The opinions expressed in this article are those of the authors and are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
Asset allocation, diversification and low or negative correlation do not guarantee a profit or eliminate the risk of loss. Alternative products typically hold more non-traditional investments and employ more complex trading strategies. Investors considering alternatives should be aware of their unique characteristics and additional risks from the strategies they use. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions. There can be no assurance that actual results will not differ materially from expectations. Fixed-income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/ or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating. The values of junk bonds fluctuate more than those of high quality bonds and can decline significantly over short time periods. The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues. The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified investments. Mortgage- and asset-backed securities, which are subject to call (prepayment) risk, reinvestment risk and extension risk. These securities are also susceptible to an unexpectedly high rate of defaults on the mortgages held by a mortgage pool, which may adversely affect their value. The risk of such defaults depends on the quality of the mortgages underlying such security, the credit quality of its issuer or guarantor, and the nature and structure of its credit support. Asset-backed securities are subject to prepayment or call risk, which is the risk that the borrower’s payments may be received earlier or later than expected. Commodities may subject an investor to greater volatility than traditional securities such as stocks and bonds and can fluctuate significantly based on weather, political, tax, and other regulatory and market developments
Invesco Advisers Inc. is an investment adviser; it provides investment advisory services to individual and institutional clients and does not sell securities. NA11676
[1] Bloomberg Barclays
[2] Invesco Fixed Income, as of November 30, 2019.
