Multiple Credit Sectors in a Singular Strategy
Aug. 6, 2014 | By Joseph Portera, Lead Portfolio Manager, Invesco Fixed Income
Joseph Portera, Lead Portfolio Manager with Invesco, describes the proprietary risk-parity allocation, a distinctive top-down and bottom-up approach, and the collaboration of global resources that has the potential to deliver strong, consistent risk-adjusted returns.
P&I: What is the strategy's overall investment objective?
Joseph Portera: The idea behind this multi-sector credit strategy came up about two-and-a-half years ago. When we looked at the overall landscape of fixed-income markets, it was clear that it was going to be difficult to garner income from plain vanilla, gilt-edged, Barclays Aggregate type portfolios. It would be necessary for investors—insurance companies, pension plans, even individuals—to focus carefully and strategically on where the markets offered the best possible returns. In the credit space, we weren't aware a single product out there could do that.
This strategy is the only one we know of that combines four major credit asset classes: investment grade, high-yield, bank loans and emerging market debt—both sovereign and corporate. The rationale was to capture credit beta tactically and combine that with one of the Invesco Fixed Income (IFI) platform's competitive advantages – the ability to select securities. So through tactical asset allocation, we can be in the right asset class and have the right beta in the portfolio, allowing us the opportunity to provide current income with capital appreciation. Over time, this can potentially provide a lower risk profile than high-yield and a higher return than traditional investment-grade credit instruments.
P&I: What was your methodology when you created the strategy?
Joseph Portera: We analyzed the historic performance of these four asset classes over the last 12 years, and we developed a full-cycle strategic allocation among the asset classes based on a risk-parity methodology. Ultimately, our modeling allocated 42 percent of the portfolio to investment-grade, 29 percent to bank loans, 15 percent to emerging markets and 14 percent to high-yield. Then we set tactical bands around those allocations, so they're elastic. Depending on where we are in a cycle, we can overweight or underweight around our full-cycle allocation, but the bands can help mitigate tail risk. For example, in our analysis, we saw that if we allocated more than 30 percent in emerging markets at any given time, the risk-return profile of the overall portfolio wasn't as attractive as if we limited the exposure. We're benchmark agnostic in the sense that we're not measuring ourselves against the Barclays Aggregate, or even the Global Agg. We also don't limit ourselves to those four core credit groups—we use insights from the teams across our platform to invest opportunistically up to 10 percent of the portfolio in residential mortgages, high-yield municipal bonds, CLOs and other credit asset classes. We offer the strategy in a separate account format, and can consider other vehicles based on the client's need.
P&I: How do you manage risk and volatility?
Joseph Portera: We view risk holistically. The base portfolio allocates equal risk weighting across the four core asset classes to generate our full-cycle allocation. That allocation becomes our benchmark and what we're compared with on a monthly basis. Tactically, the strategy is focused on spread duration and maximizing the benefit from spread duration over a cycle. That's where the tactical asset allocation comes in, but the allocation bands for each sector are there to control risk. For example, the full-cycle allocation to investment grade is 42 percent, but we will target between 30% to 60%. Outside of those bands, tail risk becomes more prominent, based on our quantitative modeling. We limit the opportunistic bucket to 10 percent of the portfolio. Being benchmark agnostic, our focus is on spread duration beta and not tracking error as you would see in a benchmark-focused portfolio. We want to capture as much excess beta as possible, but not to the point where we're taking more tail risk than needed in order to achieve the results of the objectives set forth. We monitor the overall risk of the portfolio including things like concentration risk and duration risk. For example, if our high-yield, investment-grade, and emerging market teams all like energy, we are aware of the potential volatility that could come from that sector and adjust it if we think that is necessary. The duration of the base portfolio is only about four years, and we can use floating-rate bank loans, Treasury futures, and even options on futures to manage duration risk.
P&I: Tell us how you combine your top-down macro approach with a bottom-up security selection process.
Joseph Portera: Our approach is really a marriage of overall macro views and the bottom-up security selection of our sector teams. We have an Investment Summit every six months where we gather many of our senior managers and analysts. We spend two days dissecting the G-20 economies—where is growth, where is inflation and what are the implications for our asset classes? The outcome is a strategic view of the world looking out 12 to 18 months. But we don't stop there—our Investment Strategy Team—senior representation of all our teams that integrates our top down and bottom up views- takes a critical look at that strategic view and adjusts it monthly – or more often if necessary. Carolyn Gibbs, Erik Jensen and I take those views and adjust the tactical positioning and opportunistic investing of the MSC portfolio. The allocations are based on our relative judgments of the different asset classes, supported by a proprietary rating system that combines both quantitative modeling and qualitative experience-based asset allocation. From the bottom up, we work closely with our sector, or sleeve, managers, who run the high-yield, emerging markets, banks loan, and investment-grade desks. They do the heavy lifting in terms of security selection.
P&I: Is this strategy about seeking yield?
Joseph Portera: The market mentality now is yield at any price, but recently we've taken the risk exposure down. Yield, of course, is important, and there's always going to be a yield bias in the portfolio. But if we were yield-driven, we would have been 100 percent invested in emerging markets. We're really focused on the total return. We're not just buying a bunch of triple Cs or Argentine and Venezuelan sovereigns because those are the highest yielding. For example, we're heavily weighted toward investment-grade in our emerging markets sleeve. Those are not necessarily going to have the highest yield or pay the highest dividend. Overall, one of our top five holdings is a prominent computer and electronics company. On a spread basis, it doesn't look attractive compared with Treasuries, but it's very attractive from a quality and liquidity perspective. Emerging markets and high-yield have the highest risk profile from a volatility perspective, and the maximum exposure we can have in either one is 30 percent, but we could be zero weighted if we can't find any reason to own them. The sleeve managers focus on what they do best, which is finding the best value within their sectors—they're very myopic. It's Erik, Carolyn, and my job to focus on the overall risk and relative value of the portfolio. Ultimately, this strategy is a unique combination of tactical allocation of credit beta, fundamental credit analysis, and careful portfolio construction.
P&I: Where do you see opportunity right now?
Joseph Portera: We continue to be cautiously optimistic on high-yield and emerging markets, but we have been taking profits, mainly in high-yield. We allocated as high as 30 percent to high-yield at the end of September 2013, but we're down to about 17 percent now. We were negative on emerging markets at the end of May 2013, but we're up to 13 percent now—there's been a huge compression in yield spreads to Treasury bonds. There is still value in Latin America, where we have half of our emerging market exposure, in both corporates and sovereigns, and we have small positions in Mexican and Colombian local currency. The best value right now is in some opportunistic areas. We started to invest in high-yield municipal debt at the end of last year, and we have about a 3 percent weighting. They are quite attractive on a spread and a nominal yield basis. For the most part, state and local government budgets have recovered from the crisis, and credit fundamentals have improved dramatically. This idea came from our Summit meetings and IFI's municipal bond team. Bank loans and the collateralized loan market are looking very attractive also—especially triple-A CLOs.
P&I: What are your resources, and how do you coordinate them?
Joseph Portera: We have teams of analysts in Atlanta, London and Hong Kong, plus other specialist sector teams within Invesco. We have the breadth and depth of resources to cover pretty much the whole universe that we're looking at right now. We take a global view evaluating the credit landscape around the world. For example, we used the sell-off during the Crimea incident to our advantage to buy back into places like Turkey, where banks are better capitalized, in some instances, than even their developed world counterparts. Healthcare is another example. We've spent countless staff hours figuring out what Obamacare means, who the winners are, and who the losers are. That does translate into large positions in the portfolio at the end of the day. There is a lot of collaboration among us, and we make sure that we as portfolio managers are as informed as possible about what the analysts are thinking.
Reprinted with permission from Pension and Investment Magazine. This article is provided for educational & informational purposes only and is not an offer of investment advice or financial products. Please obtain and review all financial material carefully before investing. Portfolio characteristics are subject to change without notice. All data provided by Invesco unless otherwise noted. Invesco Advisers, Inc. is an investment adviser; it provides investment advisory services to individual and institutional clients and does not sell securities.