I read with sadness about the death of David Thompson. I did not know him well but, from my perspective as an equity analyst in the 1980s, he stood out as a charismatic Chief Executive of Wolverhampton & Dudley, a regional brewer based in the West Midlands.
His tours of the pub estate, where he demonstrated great knowledge of each pub and tenant, was an insight into how a leader can connect with all walks of life.
In a reflective mood I want to highlight some of the key differences between equities and credit – given that I have seen it from both sides. In many ways credit is easier than equity fund management. As a credit fund manager, I face asymmetric risk, a lot of downside but capped upside: coupon payments and return of capital. This does not sound good – but it frees the credit manager to select the bonds they want. This is very different from the equity fund manager where not holding Amazon, Tesla, Apple and Microsoft has been career limiting. Ironically, the asymmetry of return is one of the reasons that active credit management scores well against passive strategies.
Psychologically, a credit manager tends to be pessimistic – looking for downside risk, spreading active positions across a broad range of strategies whilst equity mangers tend to be more optimistic, focusing more on what can go right and running more concentrated portfolios. What credit managers have in their favour, however, is some institutionalised inefficiencies that give active approaches a helping hand. Methodologies around benchmark construction, credit ratings and an undue focus on immediate liquidity have allowed our credit strategies to flourish over the longer term – by opposing these consensus views.
My colleagues may feel that I am being harsh on credit. Afterall, when choosing to invest in the equity of HSBC, for example, there is basically one share. Conversely, there are hundreds of debt instruments to potentially buy. Similarly, a credit manager has to assess a wide range of economic drivers – yes these are important to equity valuations as well but the multifaceted nature of credit is somewhat different.
The need to do your own research is central to our approach to credit. And the more I look at the development of ESG and Sustainable strategies the more apparent this becomes. I am concerned about the narrowness of approach that is evolving. This is stemming from three main directions: regulation that is too one dimensional; a growing reliance on third party data collectors; and a desire by asset managers to show their ESG credentials. Ultimately, this is bad for choice.
Let’s take an example of banks. They score well on Scope 1 and 2 – which focus on carbon emissions and consumption of energy. This should be no surprise and is relatively easy to assess. However, what is more difficult to judge is Scope 3 – the indirect impact of financing and investing in carbon intensive areas. Tick-box methodologies that bias investment away from areas that are easy to assess, therefore favouring sectors where there is less data and scrutiny, is flawed. This box-ticking approach is rapidly developing and I wonder whether consumers are being well served here. I think you know my answer. Yes, banks and wider financial services have a vital role to play in our economic system – but don’t let ease of ESG analysis give rise to an unbalanced approach or unbalanced credit portfolios.
Cash and government bonds
Government bond markets were a bit choppy last week – but yields ended lower in most markets. UK government 10-year yields ended just above 0.55% whilst the US equivalent moved towards 1.2%. Italian bonds consolidated recent gains with 10-year yields now similar to those in the UK. Break even inflation moved up across the curve in the US, a move mirrored at short UK maturities but not at the long end.
The Fed sounded like they are inching towards a taper although there was no change in policy. In the statement there was the addition of a sentence that notes the US economy has made progress towards the Fed’s goals of maximum employment and price stability. However, the key messages on inflation and the labour market remained – inflation is transitory, and the labour market recovery has a “ways to go”. Nicely hedged.
Data last week showed that US GDP rose 6.5% annualised in Q2, a similar pace to Q1 but weaker than consensus expectations. Personal consumption grew strongly but government spending, residential investment and inventories made negative contributions to growth. Meanwhile, survey data is consistent with Q2 marking the 2021 peak in the US GDP growth rate, with the flash PMI having cooled significantly over June and July. For now, consensus expectations of 6.6% US GDP growth in 2021, and the Fed’s median projection of 7.0% looks on the optimistic side.
Sterling perked up against both the US dollar and euro – moving towards 1.40 USD.
Some parts of the investment grade market softened over the week although indices indicated no material change. In sterling, issuance was fairly light and our focus was, therefore, on USD issuance. Our funds bought an AAA rated long-dated bond from Temasek, the Singaporean investment company. We also took part in a multi-tranche book build from Apple, before pulling out, as final pricing was above our buying level.
High yields spreads continued to give ground and China remained in focus. A further round of government interventions sapped confidence in the equity market, with a knock-on impact to credit. Real estate remained under pressure with further adverse moves in the bonds of Evergrande.
A great thing about the Olympics is that you get a chance to see sports rarely televised or covered in the media; the choice of events is brilliant. In all areas of life and work we should celebrate choice and question the bland consensus of what is right.
Past performance is not a reliable indicator of future results. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are the author’s own and do not constitute investment advice.