19 Mar 2018
Our Multi Asset team discusses how it has implemented one of its investment ideas to illustrate an unconstrained approach to targeted, long-term investing.
The Invesco Perpetual Multi Asset team believes that its unconstrained approach to investing is key to delivering targeted, long-term performance in its funds. Here, the team discusses an active idea to illustrate how their ideas are conceived and implemented.
Relying on the stock-picking skills of our Atlanta-based colleagues to identify opportunities in the US high yield market, this idea gives us a more defensive and selective exposure to corporate debt in our portfolio.
The search for yield has become a dominant theme in global markets as government bond yields have been kept low by an extended period of incredibly loose monetary policy. Consequently, many investors are now looking at other asset classes and investment approaches that offer the potential for higher returns.
The Multi Asset team believes that in a world of low growth, low interest rates and low inflation, it would still make sense to have some selective yield exposure within a portfolio, which led them to look closely at the US high yield market following a sell-off through 2015.
The ‘Credit – US High Yield’ idea was originally added to the Invesco Perpetual Global Targeted Returns Fund in early 2016 and is now also held in the Invesco Perpetual Global Targeted Income Fund, although in slightly bigger size to reflect the income focus of the portfolio. It has been in focus due to the strong performance of the US high yield market and has recently been through its quarterly review.
While the US high yield market has rallied significantly since the beginning of 2016, on a number of yield measures, spreads over US government yields were much higher than comparable spreads in Europe. Comparing the two regions’ yield to worst, for example, saw yields around 300 basis points greater than comparable yields in Europe. In addition, high yield spreads have been trading at some of their highest levels relative to investment grade (IG) spreads in the last few years.
From an economic perspective, US GDP growth has remained modest, with mild inflation and record low levels of unemployment. Consumer confidence is at its highest levels in years, supported by positive industrial production. Economic conditions remain broadly supportive regardless of the recent disorder in US politics. As the end of the credit cycle is normally sparked by a recession, this appears unlikely given these high levels of confidence.
Issuances in the US high yield space have been modest compared to those in the investment grade category, which saw some of their highest issuance levels earlier in 2017. Relatively low issuance of high yield bonds on the market would be more supportive of spreads. In addition, strong demand for the IG sector from Asian and European investors has contributed to tighter IG spreads.
Deploying the ‘M’ of their ‘TEAM’ research process, which considers other specialists’ perspectives, the Multi Asset team reached out to their fixed income colleagues around the world. For views on this US high yield idea, the team spoke to its Henley-based colleagues and was also able to consult Scott Roberts, Invesco Fixed Income’s Atlanta-based Head of US High Yield, among others.
Scott and other fixed income specialists offered the team opinions about particular segments of the market, advising caution in the retail, healthcare and auto spheres and stated that they believed credit improvement available to lower-rated bonds was also limited.
In addition, a number of risks to the high yield market that could spark a sell-off were also highlighted during these conversations, especially given current market levels. There were chiefly concerns around a policy mistake on the part of the US Federal Reserve, the inability of President Trump to enact his policies and a flare up in geopolitical issues.
Though the risks for lower quality credit have risen, the Multi Asset team still sees selective value in US high yield credit over their two- to three-year time horizon. Combining their perspective on the US high yield market and the potential for the Invesco Fixed Income US High Yield team to add further value through security selection, the team chose to implement this idea by reflecting their US high yield strategy – this gives the team a more defensive and selective exposure to corporate debt in the portfolio.
This original implementation served the team well and the idea has performed strongly for the strategy since being added in early 2016. However, given some of the risks noted above we recently limited our credit exposure by buying protection on a US investment grade credit index. This should cushion the idea in the event of a market sell-off while allowing us to benefit from the yield offered by the current holdings.
Fig 1. US high yield spread to investment grade 1
Source: Bloomberg as at 29 December 2017
1 US high yield represented by the Markit CDX North American High Yield Index; US investment grade represented by the Markit CDX NorthAmerican Investment-Grade Index.
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Investment risks
The value of investments and any income will fluctuate (this may partly be the result of exchange-rate fluctuations) and investors may not get back the full amount invested.
The Invesco Perpetual Global Targeted Returns Fund and Invesco Perpetual Global Targeted Income Fund make significant use of financial derivatives (complex instruments) which will result in the funds being leveraged and may result in large fluctuations in the value of the funds. Leverage on certain types of transactions including derivatives may impair the funds’ liquidity, cause them to liquidate positions at unfavourable times or otherwise cause the funds not to achieve their intended objective. Leverage occurs when the economic exposure created by the use of derivatives is greater than the amount invested resulting in the fund being exposed to a greater loss than the initial investment.
The funds may be exposed to counterparty risk should an entity with which the funds do business become insolvent resulting in financial loss. This counterparty risk is reduced by the Managers, through the use of collateral management.
The securities that the funds invest in may not always make interest and other payments nor is the solvency of the issuers guaranteed. Market conditions, such as a decrease in market liquidity for the securities in which the Funds invest, may mean that the Funds may not be able to sell those securities at their true value. These risks increase where the Funds invest in high yield or lower credit quality bonds and where we use derivatives.
Changes in interest rates will result in fluctuations in the value of the Invesco Perpetual Global Targeted Returns Fund.
As one of the key objectives of the Invesco Perpetual Global Targeted Income Fund is to provide income, the ongoing charge is taken from capital rather than income. This can erode capital and reduce the potential for capital growth.
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