Managing risk is key in credit markets. These are the factors to watch

• Actively managing credit macro risks is critical
• Inflation and vaccine roll-out are focus areas
• Bulls outweigh the bears – but for how long?

ONE OF THE greatest challenges running any portfolio is when to de-risk. When should a manager decide to change tack and become more defensive?

It’s the same for all asset classes, including credit markets which are often thought of as “low risk”.

In fact, losses in credit markets do occur — and can be very painful for investors — which means the right risk profile is even more critical in fixed income funds trying to achieve target returns.

“If you have a credit portfolio that’s trying to outperform by 2% versus a benchmark over a full year, and you lose 1% in a month, that’s a very bad outcome,” says George Bishay, Pendal’s portfolio manager of Income and Fixed Interest.

Bishay uses the example of March last year when financial markets collapsed. An average credit fund aims to outperform the benchmark by 2% over a year — but many lost 4% in one month.

Risk, and the appetite of a credit fund manager for risk, is reflected in the weighted average maturity (WAM) of their portfolio. A longer WAM is reflective of a bullish credit outlook. A shorter WAM suggests a bearish outlook.

When actively managing a credit fund, it’s important to be more defensive during volatile times, such as March last year.

Right now, credit spreads offer value in a low interest rate environment and Bishay has reflected this in his credit portfolios.

“It comes down to macro factors,” he says. “The huge amount of fiscal stimulus that we’ve had is powerful. That stimulus supports employment and ensures the economy doesn’t fall in a heap.”

“Then there’s an incredible amount of monetary policy stimulus that supports liquidity in the system. The cash rates around the world are near zero and because of that investors are chasing yield, which is supportive for credit markets,” Bishay says.

“You also have global company earnings being revised up.”

US corporate earnings, and what happens on Wall Street, has a big influence on local credit market pricing. The local credit market is correlated with US credit markets. And US credit markets reflect what’s happening in US equity markets.

A rally in US equities tends to prompt a rally in US and AUD credit spreads.

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“I’m focused on US equities,” Bishay says.

While the roll-out of vaccinations around the world adds to his argument for accepting greater risk in credit markets, it could quickly become a negative.

“COVID cases are picking up globally, but so are vaccination rates. We know if you get vaccinated you are less likely to transmit coronavirus and less likley to end up in hospital or die. But we don’t know the exact numbers,” Bishay explains. “We don’t really know the accuracy of the trial efficacy rates of vaccines. We don’t yet have the full picture.”

“The vaccination roll-out supports the stronger macro view, but it is also a risk.”

Bishay says the other major risk is a disorderly rise in interest rates. “What if there’s a jump in interest rates because inflation proves not to be transitory and is higher than expected? That’s a risk.”

But for now, the bull case over-rides the bear case. But as Bishay puts is: “I’m constantly focused on when to de-risk the portfolio.”

About George Bishay and Pendal

George Bishay is a portfolio manager with Pendal’s Bond, Income and Defensive Strategies team.

Led by Vimal Gor, Pendal’s BIDS boutique is one of the most experienced and well-regarded fixed income teams in Australia. In 2020 the team won the Australian Fixed Interest category in the Zenith awards.

The team oversees $22 billion invested across income, composite, pure alpha, global and Australian government strategies with the goal of building Australia’s most defensive line of funds.

Find out more about Pendal’s fixed interest strategies here

Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.

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