Hermes co-head of credit Fraser Lundie is eschewing duration-focused plays as a defensive tool in one of his portfolios, instead resorting to a “bearish bucket” including short positions for protection against downside risk.
Mr Lundie, who works on the asset manager’s $65m (£52m) Absolute Return Credit fund, said short positions through credit default swaps in names such as Hewlett-Packard served as downside protection.
The manager added that many investors rely too heavily on duration in bond portfolios, and instead said that duration has always been “pretty negligible” in this fund.
“We feel there is an over-dependence on it as downside protection,” he explained. “Some people say, ‘I like credit but I don’t like duration, therefore I’ll buy a short-duration fund, or a senior secured loan fund’. The problem with that is you’re giving up convexity, your ability to capture the upside is limited.”
Convexity is a measure of how much a bond’s value changes as duration increases.
As part of Mr Lundie’s strategy, the fund has a number of short positions, the biggest of which is in US oil field services company Weatherford International, which Mr Lundie felt was too dependent on capital expenditure from some of the major oil producers.
“If we’re sitting here in a year’s time and oil’s still going to be in the low $40s, these guys are going to struggle because they’ve already done a lot of the can kicking, in terms of raising secured finance and selling assets. There’s not much left for them to do to improve the picture,” he explained.
The manager has also shorted software firm Hewlett-Packard because of the “secular change” of consumers buying fewer desktop computers and printers making for slim growth prospects.
Meanwhile, the manager has been adding to the fund’s emerging markets exposure in what he has dubbed “a decent shift”, focusing mainly on telecommunications businesses.
Over the past year, the fund’s emerging market allocation has shifted from steel, cement and energy companies, as well as firms with dollar revenues, into a greater allocation towards telecoms.
Mr Lundie said that despite the “valuation mismatch” of dollar debt with local currency revenue, improved sentiment for emerging markets and “rock-solid balance sheets” has made these bonds an investment grade play with good growth metrics.
“In a world where there’s not too much growth and a lot of re-leveraging of balance sheets in developed markets, we felt that you were being paid to take that risk and that’s been a decent shift in the fund,” Mr Lundie said.
In a note issued last month, the manager warned that “close to half of the market yields” in developed market fixed income were below 1 per cent. He also noted emerging market hard-currency funds had $12bn of year-to-date cumulative flows, reflecting improved sentiment.
The fund has added “incumbent telecom players in emerging market credit”, such as VimpelCom in Russia, Millicom in Central America, VTR in Chile, and Türk Telekom in Turkey.
