A better risk-reward with a strong focus on risk

In an environment of continued low rates, investing in short-dated bonds makes a lot of sense.

High yield is specifically of interest, as it tends to do well in times of rising rates. Still, high yield bonds also bring higher risks. Managing default risk and selecting issuers with the utmost care, is the way to go. Only a combination of strict risk management and discipline will yield the expected results.

A high yield bond strategy with short maturity is designed for capital preservation and low volatility, and this is also the underlying philosophy for the day to day management. In essence, the strategy invests in bonds issued by companies with a rating below investment grade. Bonds with a rating below investment grade are usually considered to be high risk, but the design of the investment process and the constraints of the fund result in a risk/reward ratio that is quite compelling.

The focus lies on fundamental bottom-up credit picking, the analysts will thoroughly vet the companies in the investment universe in order to find attractive investments. In addition, we also apply a quantitative screen to exclude bonds that are too risky. As exhibited below, bonds with a spread that is too high (i.e. at the right hand side of the Gaussian curve in the exhibit) will be excluded from the portfolio. A spread that is too high for the company’s rating means that the market is pricing in more default risk than implied by the rating. Those bonds are excluded from the investment universe, and if the bonds are already in the portfolio, they will be sold. This procedure is strictly adhered to.

The credit analysts are crucial to the investment process. Each analyst covers two to three sectors. A thorough investigation of a company’s fundamentals is carried out in a standard framework that enables us to compare companies within an industry but also across industries. Apart from a study into a company’s competitive positioning, management’s track record and risk appetite and potential ownership/governance issues, the analysts will also make financial forecasts of the company looked into. Assessing free cash flows over the coming few years and stress-testing the assumptions enables us to have a very good view on the potential risk/reward for each bond. We may also take on a limited position in non-rated issuers, i.e. companies that do not have a rating by one of the major rating agencies (S&P, Moody’, Fitch). In that case, our analysts will draw up a rating for the company based on Moody’s methodology.

Marc Leemans, CFA – Senior Portfolio Manager – Degroof Petercam Asset Management