The RLAM Multi Asset Credit Fund team has continued to deliver total returns close to the high yield market while providing consistency in income during the pandemic. RLAM’s Khuram Sharih explores the sector’s strengths
The longstanding hunt for yield and uncertainty over the path of interest rates has seen investors continually look beyond traditional equities and bonds for higher returns over the past decade.
Yet finding the right balance of assets that can provide yield at an acceptable risk level and outperform through different periods of the credit cycle is no mean feat - particularly given the volatile and unexpected market conditions experienced in the first half of 2020 as a result of a global pandemic.
With investors today increasingly concerned about the risks of a turn in the market cycle, and difficulty in finding attractive places to invest to achieve return and yield objectives, the flexibility and diversification merits of the multi-asset credit sector have proved to be promising, particularly for those looking to reduce risk whilst still accessing strong return prospects.
According to Khuram Sharih, manager of the Royal London Multi Asset Credit Fund, one of the key benefits of multi-asset credit today is its ability to provide investors with flexibility during different periods of the credit cycles, or arguably when they need it the most.
Below, Sharih explains how the multi-asset credit sector has come of age over the past year and the opportunities and challenges facing the sector in 2021.
What are the key benefits of multi-asset credit in 2021?
Multi-asset credit has a broad definition. At one end of the spectrum, you have highly liquid strategies. These are primarily investment grade focused funds with corporate and government bonds with more duration risk and have a greater focus on capital appreciation rather than income. At the other end of the spectrum there are very illiquid opportunities including distressed debt and private credit, where the return profile is higher but there are concerns about volatility and liquidity.
The approach we take with the Royal London Multi Asset Credit Fund is to use what we call the ‘alternative' part of the multi-asset credit spectrum. Our focus is on providing an enhanced return through the cycle across several asset classes but at the same time considering secondary market liquidity. This allows us to adapt the holdings within the fund to reflect our view of where we are in the credit cycle as market conditions change.
The investment process can be summarised in three key steps: incorporating macro views, risk overview and stock selection. This combines top-down views with detailed bottom-up fundamental analysis to arrive at the most appropriate positioning based on the team's analysis of the credit cycle.
Last year demonstrated it is almost impossible to predict the future, so investing in a strategy that dynamically allocates to different types of credit can help ensure optimal positioning in light of market conditions.
Given where interest rates are, income is likely to be a key driver of return going forward. We believe that the attractive income yield of the strategy, combined with its limited interest rate sensitivity (short duration), should help protect against potential interest rate rises and help deliver attractive performance for investors. This is particularly important for pension schemes looking to shrink deficits and pay member benefits.
Macro view analysis
Source: RLAM. For illustrative purposes only
2020 was a turbulent year. What are the big lessons learnt from the Covid crisis from the viewpoint of a multi-asset credit manager?
Since the launch of the fund in 2017, there have been several factors that have driven market volatility, making management of the fund quite eventful.
Last year's pandemic-induced sell-off caught the market off guard. We saw spreads in high yield, investment grade, and loans widen threefold over a matter of weeks from late February going into March. We effectively went through an entire credit cycle within a matter of a few weeks and a number of lessons were learnt about the market environment and investor behaviour too.
One of our biggest lessons, however, was how willing policymakers are to adapt to address issues that have significant ramifications to the global economy. This was perhaps a surprise for some investors, given we had been hearing commentary for quite some time that policymakers were running out of options with respect to tools available to support future economic stability.
Yet the purchase of investment grade corporate bonds by the Federal Reserve and the US Treasury, and the expansion of that programme to fallen angel/high yield credit and then ETFs were unprecedented policy measures that demonstrate their adaptability and ability to support the economy.
How have defaults and downgrades impacted the market?
Currently, default rates on a global basis are around 5.5%, with many defaults relating to the energy sector. We have also seen higher default rates in consumer and certain service-related areas. Excluding these sectors, the default rate is less than 3.5%. By correctly navigating through the credit cycle and selecting the appropriate credits during the stages of the credit cycle, we believe we can find attractive risk-adjusted returns while successfully avoiding defaults. We also believe that the current forward looking default environment remains benign.
In addition, while initial concerns last year focused on the potential for a significant number of downgrades (and in fact we did experience a material increase in downgrades as ratings agencies responded quickly in the first quarter of 2020), the high yield market has evolved considerably over the past two decades and therefore was better placed to absorb the fallen angels. Additionally, the relative favourable credit quality of the fallen angels served as a net positive to the asset class as a whole and history has shown that high yield has consistently outperformed following a major downgrade cycle.
Moreover, the high yield asset class has continued to diversify over the past year as larger players have entered the sector. These fallen angel companies were previously investment grade companies so have a deeper capital structure, better balance sheets, and a broader investor base. We feel this makes the high yield market stronger and deeper as an asset class.
What do you expect the impact of increased government spending to be on some of the opportunity set that you're looking at?
Government spending has continued to increase and so far, the low interest rate environment has been supportive of this type of spending. But investors are rightly always asking: ‘who is going to pay for this?' There are concerns regarding a rise in corporate tax rates in the US and a tax on wealthier individuals more generally as well.
It is important to remember we now have a sustained history in terms of fiscal support through crises, including during the global financial crisis. What we are now seeing (in addition to what we saw during the pandemic through support for corporates and the labour market), are numerous programmes for infrastructure development, healthcare, education, and housing. These investments will have a huge impact in terms of providing support to businesses in these areas and there is a lot of potential that in turn it will create jobs, increase disposable income and support spending. The impact on the investment market as a result could be significant.
Are you participating in new issuance currently, or focusing more on the secondary market?
We are participating in the new issuance market, but we are being selective in terms of seeking the right opportunities. In the secondary market, given the strong rally over the past several months, we are taking a more measured approach. We have selected credits that we believe reflect not only attractive relative value but strong fundamental value as we move through the credit cycle.
There are a number of factors to consider when we assess the quality of an issuance: the industry and type of business, management and ESG policies, and cashflow profiles. We also look at the structural features, including where it sits within the capital structure, time to maturity and protective features within the instrument. This helps us assess how the asset may perform through the cycle.
Having said that, we have recently found opportunities in the consumer, services and industrial sectors. For example, in the consumer sector, we invested in market leaders or very strong brands that have sustainable cashflows, good overall support from their customer base, and have demonstrated their durability through the credit cycle. Similarly, there have been some attractive opportunities within industrial market leaders that have good market positioning, sound liquidity, and the ability to benefit from economic tailwinds.
Khuram Sharih is the manager of the Royal London Multi Asset Credit Fund
The value of investments and the income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested.
Find out more about RLAM's multi-asset credit and fixed income solutions at rlam.co.uk/fixedincome
For professional clients only, not suitable for retail clients.
This is a financial promotion and is not investment advice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change.
The Royal London Multi Asset Credit Fund is a sub-fund of Royal London Asset Management Bond Funds plc, an open-ended investment company with variable capital and segregated liability between sub-funds. Incorporated with limited liability under the laws of Ireland and authorised by the Central Bank of Ireland as a UCITS Fund. It is a recognised scheme under section 264 of the Financial Services and Markets Act 2000. The Investment Manager is Royal London Asset Management Limited.
For more information on the fund or the risks of investing, please refer to the Prospectus or Key Investor Information Document (KIID), available via the relevant Fund Information page on www.rlam.co.uk.
Issued in May 2021 by Royal London Asset Management Limited, 55 Gracechurch Street, London, EC3V 0RL. Authorised and regulated by the Financial Conduct Authority, firm reference number 141665. A subsidiary of The Royal London Mutual Insurance Society Limited.