Supply dynamics and credit-investor strategy
In the absence of senior supply from domestic banks, Australian credit investors have more capacity than ever for alternative supply. This should provide a supportive environment for corporate issuance – though the focus is likely to remain on high-quality issuers.
YUAN The TFF [term funding facility] makes things very difficult as bank yield has tightened aggressively. Some financial bonds are trading at levels similar to semi-government and other higher-rated issuers.
The net result is lower yield across the board. But there is not much investors can do in an investment-grade credit mandate completely to offset lower yield. The support to date for long-dated corporate deals seems to be a product of low yield and limited supply of quality issuers.
We have not changed our approach too much, though. We are still trying to buy high-quality companies while maintaining price discipline. These bonds are multiyear investments so if we join the herd to buy a low-quality issuer it just creates a ticking time bomb in our portfolio further down the track.
BAILLIE We went into the pandemic with low credit-risk exposure relative to our medium-term risk budgets and the way we responded has been slightly different.
At first, we leaned into the excessive illiquidity premia that were available. We picked up some very short-dated paper, at 12-18 months, some of which was trading at spread of around 300 basis points. Despite the uncertain outlook, we had enough visibility to know there was sufficient liquidity to meet the bonds’ shorter-horizon maturity profile.
Even after the announcement of the TFF, spreads are still relatively wide to historical levels and an element of liquidity premium is embedded in this. Credit premium is still quite wide on a historical basis, relative to the expected loss experience over time. We think credit still looks attractive despite the uncertainties.
We have been able to extend our credit duration by moving up the curve to target the 5-7 year bucket and beyond for names we have high conviction in. This is about taking advantage of curve steepening to earn slightly higher carry for our portfolios.
Central-bank activity is hugely supportive of the Australian dollar market. We are looking at a hole of up to A$40 billion (US$29.5 billion) of credit supply that will not be there in 2021; the RBA [Reserve Bank of Australia] is taking out about A$32 billion of major-bank senior-unsecured maturities alone. This technical factor will be an overwhelming influence despite the economic outlook.
Added to this is the low-yield environment, which we think will be supportive as investors reach for yield. It is a slightly different story down the credit curve, especially for ‘cuspier’ low-triple-B companies and high-yield issuers – the latter because they are not direct beneficiaries of any of the central-bank buying programmes out there.