By Kathleen Gaffney, vice president, Loomis Sayles
THERE IS no denying that 2011 was a challenging year, with many arguing that it has been somewhat difficult to find real bargains in the market. Our style at Loomis Sayles, an affiliate of Natixis Global Asset Management, is multi sector with a large amount of exposure to credit, and therefore 2011 proved to be a tough year from the performance standpoint.
However, in Chinese, the word for crisis and opportunity are the same, and this is how we view the market at the moment. We saw a tremendous flight to quality last year with risk weighing on the market and investors feeling uncertain and concerned not to repeat the same mistakes as 2008. However, with our long term stance we are able to acknowledge that we are in a transition period of sustained low interest rates but we see a number of positive signs, particularly in the US, that the economy is continuing towards recovery and the prospects continue to improve.
We believe opportunities are there if you look hard enough and have found these across the Middle East and North Africa (MENA) especially if we look at some of the corporate issuances from DP World and TAQA. There are also opportunities arising from utility companies which seem to be solid investments.
More generally, fundamentals are improving, not only in the US but across the globe, and due to a steep yield curve there are returns to be made, but these do come with an increased level of risk. Investors need to calculate the level of risk they are able to hold within their portfolio, but if applicable investors will be well rewarded for the risk they take.
At the moment, a lot of new issues are coming to market that are being snapped up extremely quickly. In general, I feel we are set for a much better year due to low interest rates and investors would like to see the opportunities to generate some decent total returns.
From a fixed income standpoint, in such a low rate environment, the best opportunities are in high yield bonds with fundamentals improving; this is also a good time to look at credit risk; the caveat being that we shouldn’t compromise on quality and we recommend avoiding the ‘CCC’, the lower quality end of the high yield market. Due to the high leverage and positive, slow growth, the weaker credits could be challenged in this type of environment, with a significant default risk at that end of the market.
As mentioned, it’s generally a good time to take risk- we have been building up our convertible positions in fixed income securities (that are a bit of a hybrid in that they have the option to convert into the underlying equity) which makes perfect sense in the current market, allowing us to focus on high yield credits with the potential for some significant equity upside, if we think the underlying equity looks attractive.
Following the events of 2008, equity valuations have been brought to levels that are giving us an opportunity to look at these types of bonds. A mixture of equity and fixed income can bring with it some potential upsides which could be very important as the economy continues to recover; especially as we will see rising interest rates at some point. What better way to fight rising interest rates than to own a fixed income security, a bond that actually has the ability to move up in price when your typical bond, such as a risk free treasury bond, is most likely generating negative returns?
We are in a very interesting transition period as the US continues on the road to recovery, collecting coupons, having some yield and looking for companies that can do well in a low growth environment is a great way to generate significant excess return, relative to the market. Some of the risk that weighed on the market, particularly in Europe, is starting to dissipate. The big issues for markets right now is firstly, slower growth as austerity measures kick-in across Europe; secondly, the current, significant geopolitical risk and thirdly, the elections on the horizon in the US which could force some decisions on what has become a very dysfunctional US political system.
In the Middle East there is currently a premium available, simply, as it is not completely understood. This is one of the reasons that we currently hold the companies mentioned, such as DP World and TAQA. When our analysts look at their fundamentals from a financial standpoint, they are solid credits but the geopolitical risk is being priced in, which I am sure is not fair to do on a corporate security, and therein lies the opportunity. Risk premium offers a tangible opportunity to investors who can really understand what the fundamentals are. There are bargains to be found in the Middle East as companies have strong fundamentals and good cash flows supporting them.
Investors would be misreading the situation if when they hear of a potential conflict in the Middle East they simply avoid names that are connected with the region; that’s a missed opportunity. Investors need to look at a company’s fundamentals, not just where it is based. MENA countries are experiencing tremendous growth and possess significant financial resources with countries going through some noticeable changes. At this interesting time, we would encourage investors to keep an eye on the region and not lose sight of these exciting opportunities.