Embracing opportunities in fixed income and credit markets

From cheap credit to slowing global growth, the potential for strong returns is shrinking. Byron Capital Partners explains these structural headwinds, and how flexibility is the key to overcoming them

 
Various challenges are impacting markets across Europe. Byron Capital Partners plans to address all of these in order to boost economic growth 
Interview with: Christos Kassianides, Investment Manager, K&B Global Total Return Fund, Byron Capital Partners
July 19, 2016

As any observer of finance and economics knows, present market conditions are both challenging and often illogical. These conditions are presenting a challenge for asset management firms and private investors the world over. Global growth is still weak, while increasing regulation is affecting the structure of global financial markets. Market-moving political flashpoints – from Brexit to the Middle East – persist. Polices such as quantitative easing and ultra loose monetary policy have made even decent returns harder to deliver, while liquidity remains weak.

World Finance spoke to Christos Kassianides, Investment Manager of the K&B Global Total Return Fund at Byron Capital Partners, to explore these challenges facing markets and his own firm. Kassianides also explained some of the challenges that have presented themselves under these new conditions, and his opinion on the outlook for fixed income and credit markets going forward. In a climate that is increasingly volatile and hard to make sense of, Kassianides sheds some much-needed light on the opportunities.

How have you seen the market for asset management change recently?
There have been complaints from investors that asset managers promise the world and, in reality, deliver little. Not just in terms of performance and returns – for example according to research by Bank of America, just 19 percent of funds outperformed the S&P 500 in the first quarter of 2016 (the worst performance in 18 years) – but in terms of client service and personal relationships. Global growth is still and will most likely continue to be weak. That continues to put pressure on expected rates of return for risk assets, and with negative interest rates, it is even harder for asset managers to find acceptable returns today.

Regulation is also a game changer. Asset managers are facing year-on-year higher regulatory and compliance costs, and this trend alone is forcing consolidation in the asset management and private banking industry. Banks are also cutting costs and are no longer either able or willing to absorb and transfer liquidity risk as a result of regulatory changes, including the Volcker rule and Basel III regulations. This has affected market liquidity, particularly in global bond markets.

We feel that today many banks have moved too much of their operations to e-commerce and have lost the relationship with the clients

How have some of these changes influenced the way we invest in global bond markets?
Liquidity is definitely a concern, and market makers are changing their business models accordingly. It is difficult to trade corporate credit these days without incurring liquidity and transaction costs. The evaporation of liquidity manifested itself particularly severely at the start of the year, when global financial markets experienced a spike in volatility and a sell off materialised.

As a result, you have to be cautious when you invest in the global bond markets, but on the positive side for unconstrained investors, this brings opportunities provided you do your homework – particularly for smaller asset managers, who are more nimble.

What other factors have influenced global bond markets?
Many macro factors have recently influenced global bond markets, and the net result is that we have experienced higher volatility, and we expect that trend to continue in the future. We have seen political factors such as the bailout of Greece, sequential conflicts in the Middle East, and terrorism is on the rise again.

Negative interest rates in developed economies – together with the quantitative easing programmes implemented by central banks – are having an impact on bond market pricing. The collapse of commodity prices has also had a major impact on high yield bond markets, but personally I think the real influence is the concern regarding global growth, and where that growth will come from going forward.

What differentiates K&B Global Total Return Fund from other funds?
As a boutique fund house, we treat each euro into any fund we manage as irreplaceable. These days, we believe capital preservation is equally as important as capital gains, so we focus first and foremost on risk management rather than ‘swinging the bat’ to achieve the highest possible returns.

As opposed to product offerings from some fund houses where the investors often end up just owning an index the K&B Global Total Return Fund is not constrained by an index, and takes positions in ‘off the run’ names where we believe alpha generation is possible. The smaller size of the fund also makes this strategy more effective. It is UCITS-compliant and offers investors weekly liquidity, and we actually have investors who view the fund as an alternative to cash, given the punitive returns offered by most bank accounts in the era of a zero interest rate policy, or even negative interest rate policy in some countries.

As a boutique fund house, we are obliged to deliver full transparency and visibility on the portfolios to our investors, and we regularly have one-to-one meetings with all our investors, always involving the fund managers, to ensure they are fully briefed on the current themes and positions in the portfolios.

We feel that today, many banks have moved too much of their operations to e-commerce and have lost the relationship with the clients. We strive to maintain a close relationship with our clients, as we truly believe this is the best way to earn and maintain the clients’ trust. After all, investing is ultimately about trust.

What are some of the biggest challenges the company has faced recently?
Low economic growth and the corresponding structural shift to lower returns remains a challenge for everyone in the industry. Negative rates have also complicated an already difficult investing backdrop.

While performance problems have been the main issue facing asset managers in recent months – with the first quarter of 2016 being a very difficult quarter for the vast majority of the asset management community as outlined above – the K&B Global Total Return Fund actually had a very good first quarter of the year, returning +1.94 percent net of fees.

Having a footprint in south east Europe has created distribution challenges following capital controls implemented by Cyprus and then Greece, meaning inflows into funds have been constrained following policy measures implemented as a result of unprecedented macro events in southern Europe. As a result, we have shifted our distribution focus to other geographies.

And what opportunities have you encountered?
The volatility in the market has created some trading opportunities, which the fund has capitalised on as noted in the performance numbers above. In terms of sector-driven opportunities, when everyone was selling commodity-focused companies at the beginning of this year, this created some interesting opportunities provided you did your homework correctly.

As an example, one year the Anglo American paper was yielding seven percent, and we were comfortable in taking a small position, as their balance sheet in the short term remains strong in our view, with ample liquidity to repay this debt. The underperformance of our larger competitors also creates distribution opportunities for products such as the K&B Global Total Return Fund.

For the bond market in the short and long term, what is the company’s global outlook?
The bond market feels like it is running on morphine. The European Central Bank expanded quantitative easing by €20bn per month and decreased interest rates to -0.4 percent. This should support bond prices, but once the ‘morphine’ wears off it will be interesting how the market reacts, especially when German government bond yields are negative out to nine years.

We believe credit spreads should continue to tighten in Europe, but we also acknowledge that the threat of the Brexit referendum has caused material volatility and further political risk in the Euro area where Greece and its creditors are discussing (yet again) a bailout agreement. In the US we think the yields will remain relatively depressed given a dovish Federal Reserve and mixed economic data.

What are Byron Capital Partners’ plans for the future?
As both an Alternative Investment Fund Manager and UCITS Fund Manager, the company is focused on the performance of existing product offerings, but will continue to look to roll out new products (some bespoke in nature) that cater to the current global investing environment and match demand from investors, particularly in niche areas.

While the environment is challenging for independent asset managers like Byron Capital Partners – particularly against an increasingly demanding regulatory backdrop – it creates opportunities to work and cooperate with other independent asset managers to enhance scale, service existing clientele and create new products in order to bring to market value-added product offerings, be it an UCITS or AIF format. Regulation is here to stay, and we have positioned the business accordingly.