Transcript Multi-Asset Credit Strategy

The Folly of Forecasting:
Active Management in an uncertain world
Richard Ryan
23 September 2014
Forecasting the Future
“Prediction is very difficult,
….especially if it’s about the future”
Niels Bohr (1885-1962)
Danish physicist and Nobel Prize Winner
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Ever wanted to know the weather for next year?
…would anyone care to risk losing money if this is wrong?
Mon 25/1 Tue 26/1
2016
2016
Wed 27/1 Thu 28/1
2016
2016
Fri 29/1
2016
London
4C
-1C
3C
5C
10C
8C
6C
-2C
6C
3C
9C
5C
2C
5C
1C
Birmingham
Edinburgh
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Source: M&G, TheWeatherWiz.com, long range forecasts as at 14 January 2015
Why do we crave forecasts?
• Human nature – we seek clarity, we need to plan
• Many players claim they can forecast reliably
• We are conditioned to respond to them
• Seen as a key advantage
4
Where might we look for reliable forecasts?
… The Bank of England?
UK GDP (Q4 2007- Q3 2017, Quarterly, %YoY)
6
4
Bank of England Rolling GDP Forecast
(from 3 years prior)
2
0
-2
Actual GDP
-4
-6
-8
Q4-07 Q3-08 Q2-09 Q1-10 Q4-10 Q3-11 Q2-12 Q1-13 Q4-13 Q3-14 Q2-15 Q1-16 Q4-16 Q3-17
Central Banks, for all their ‘inside’ economic data, are poor forecasters
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Source: M&G, Bank of England, Monetary Policy Committee data. As at 30 September 2014
Where might we look for reliable forecasts?
… The Federal Reserve?
US GDP (1989-2006, Quarterly, %YoY)
6
Actual average GDP 4%
5
4
3
Actual GDP
2
Fed Policy assumed
2% ‘normal’ GDP
1
0
-1
-2
Dec-89
Dec-91
Dec-93
Dec-95
Dec-97
Dec-99
Dec-01
Dec-03
Policy makers have the data but struggle to make sense of it
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Source: M&G, US Bureau of Economic Analysis data, 1989 to 2006 (including data revisions), Bloomberg. As at 30 September 2014
Dec-05
What is our trust in Central Banks based on?
• Markets believe in Central Bank omnipotence despite
–
consistent failure to accurately forecast growth and inflation
–
had their forecasts been accurate, policy and outcomes would have
been different
• Now we are trusting them to be the ‘greater fool’
–
the last buyer (through QE) of ever more expensive assets
• ECB President Mario Draghi: “Whatever it takes…”
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Can we rule out a policy error?
Countries that have ‘successfully’ negotiated a ‘QE’ programme:
“ This page is intentionally blank* ”
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*Because there aren’t any
Getting the Economic forecast right is no guarantee
Do expectations of UK growth and monetary policy drive Gilt returns?
Forecasts:
4.00
3.8%
(High)
3.50
31 December 2014 Gilt Yield forecasts
(range of forecasts, as at 31/12/13)
3.2%
(Average)
3.00
%
2.6%
2.50
(Low)
2.00
Actual 1.8%
1.50
Dec-13
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Feb-14
Apr-14
Jun-14
Aug-14
Source: M&G, Bloomberg, *Concensus Economics Inc. forecast data 9 December 2013. As at 31 December 2014
Oct-14
Dec-14
What can we rely on?
The investment environment requires us to adapt our focus
New thinking is required to take advantage of an
evolving market
–Investing on the basis of ‘forecasts’ is flawed
–Remove the barriers between asset classes
–Remove unwanted and unrewarded risk
Think about the underlying risks you are exposed to!
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Multi-Asset Credit: a broader opportunity set
Requires expertise in all of these asset classes and capital structures
• Investment Grade corporate bonds
• Asset Backed Securities (ABS)
• High Yield Bonds
• Mortgage Backed Securities
• Senior Secured Loans
• Cash, Floating Rate Notes
Risk versus return of credit assets
Return %
Senior Loans
High Yield bonds
Cash
FRNs
Investment
Grade
Credit
Category 1
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Source: M&G, illustrative
Risk (volatility
/ loss) 3
Category
2
Category
Category 4
How does a company borrow?
Loans to public and private companies, with different features
Company borrowings
Key features include:
Senior
secured
bonds
Senior
secured
loans
Unsecured borrowings
(bonds)
Equity
(share capital)
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Source: M&G, illustrative
•
Public or private investments
•
Fixed rate or floating rate returns
•
Secured or unsecured
Investment opportunities – High yield bonds and loans
Bonds and senior loans different features, but how different?
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High yield bonds
Senior loans
Fixed coupon (some floating)
Floating coupons
Public disclosure & trading
Private disclosure & trading
Secured & unsecured
Secured
Weaker investor position
Stronger investor protection
Source: M&G, illustrative
Investment opportunities - High yield bonds and loans
Bonds & loans issued by less credit-worthy issuers but offering higher returns
High yield
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Source: M&G, illustrative
Senior loans
Investment opportunities - Asset Backed Securities
Bonds with a pool of underlying assets
Pool of assets are
‘security’ for a
number of bond
issues with different
risk/reward
characteristics
AAA
Returns on the
assets repay the low
risk lenders first
Lower risk,
lower return
A
A
BBB
BBB
BB
AAA
AA
AA
Pool of
assets
Income and capital flow down
Higher risk,
higher return
BB
Capital losses flow up;
riskiest bonds bear first losses
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Source: M&G, illustrative
Credit offers a range of characteristics
What other risks should you be compensated for?
Ratings
Current
spreads*
Seniority
Secured
Liquidity**
Complexity
Cash
AAA
-

n/a

Low
Government Bonds
AAA
-

n/a

Low
Investment Grade
Corporates (€)
AAA-BBB
30-110

Varies

Low
Senior Mortgages
A
175-225


XXX
High
AAA-B
25-450
Varies


High
Senior Loans
BB-CCC
350-425


X
High
Euro High Yield
(Ex-Financials)
BB-CCC
390
Varies
Varies

Medium
Asset Back
Securities
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Source: M&G, BofA Merrill Lynch indices (Ref. ER10, ER40, HEAD), as at 31 December 2014. *Spread to LIBOR (indicative). **Based on daily dealing.
Barriers lead to mis-pricing of risks
In separating assets into ‘Silos’ investors hold correlated assets
Investors allocate top down into ‘Silos’
Sector
Senior
Loans
High Yield
Credit
Investment
Grade
Credit
The same issuer will often have debt issued in multiple silos:
e.g. Auto Issuers, Retailers, Banks
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Source: M&G, illustrative
Asset
Backed
Securities
Removing the ‘silos’ increases opportunities
Investment Grade Credit
BMW
Honda
Mercedes
Renault
Investment
Ford
Toyota
Grade
Peugeot
VW
Credit
Senior
Loans
Fiat
GM
Renault
High Yield
Peugeot
Credit
Schaeffler
Jaguar
SchaefflerSenior
TI Group Loans
High
Yield
Credit
Asset
BMWBacked Renault
SecuritiesPeugeot
Mercedes
Ford
VW
Asset Backed Securities
It makes more sense to assess investments in a common sector
framework, without asset class barriers or investment ‘Silos’
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Source: M&G, Bloomberg, Credit Suisse as at 31 December 2014
Corporate bond market spreads
Stock selection presents plenty of opportunities
Asset swap spreads of £ Investment Grade and € High Yield credit (bps, Rated A+ to B-)
2000
1800
1600
1400
1200
1000
800
600
400
200
0
A+
A
A-
BBB+
BBB
BBB-
BB+
BB
BB-
B+
B
Opportunities exist across public and private debt issues
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Source: M&G, Asset swap spreads. BofA Merrill Lynch Corporate £ Non-gilt Index (Ref. UN00), Euro High Yield Index (Ref. HE00), Euro Broad ex Sovereign Index (EX00):
composite credit rating derived from average of S&P/Moody’s/Fitch, Credit Suisse Leveraged Loan Index S&P rated issues, 4 year discount margin, as at 31 December 2014
B-
Multi-Asset Credit strategies demonstrate new thinking
Delivering higher performance with lower volatility
Excess returns to Libor, local currency, normalised (Dec 2015, April 2007 =100)
140
130
120
110
100
90
Volatility*
80
70
60
£ Multi-Asset Credit
4.37
£ Credit
6.76
€ Lev. loans
9.74
€ High yield
13.99
50
Apr-07
Apr-08
£ Multi-Asset Credit
20
Apr-09
Apr-10
£ Credit (UC00)
Apr-11
Apr-12
€ High Yield (HEAD)
Apr-13
Apr-14
CS Leveraged Loans
Source: M&G, BofA Merrill Lynch, Credit Suisse as at 31 December 2014. *Standard deviation of excess returns since inception 26 April 2007
Multi-Asset Credit for Pension schemes
• Accessing
the credit risk premium while minimising interest rate
exposure
•A
flexible and unconstrained approach free from the ties of a
benchmark
• Access to a broad range of credit assets, both public and private
• Can complement a Liability Driven Investment solution
• An extremely diversified approach to reduce downside exposure &
volatility
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Source: M&G as at 31 December 2014
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