Passive strategies are becoming increasingly commonplace in the bond market but there are four key areas active can retain an advantage, Citywire AA-rated Henrietta Pacquement has said.
While admittedly an advocate of active investing, the head of investment grade at Wells Fargo AM Credit Europe said passive funds provide a welcome challenge, but investors need to keep their eyes open.
‘I think it makes sense, if you look at the current environment, it is still low yield. Investors need to look at the whole thing when looking at investment, which includes cost, so looking at passives makes sense,’ she told Citywire Selector in response to a question about increased passive bond fund launches.
Here she outlines the four reasons fund buyers should stay on the active side of the fence.
#1. Weightings worries
Pacquement said the concern over passive indices is that in bonds the largest constituents are those with the most debt, rather than in an equity scenario which is done by revenue.
‘Debt is not equity, so if you are looking at indices, you are looking at market weight. As a result your weight is overweighting the companies borrowing the most rather than earnings. If you look at the European markets, it means a lot in VW and EDF, which you can hold, of course, but that comes with its own challenges,’ she said.
#2. New issuance opportunities
Pacquement said there are concerns that the indices are slow moving and unable to fully capitalise or rebalance to capture new players in the market. ‘Companies will come often to the market and they will come at a premium and that is a very good risk-adjusted way of generating returns in the fixed income markets.
‘I would say that is 50-60% of our investments are made on the new issuance market so that is an interesting added value. Passive guys will wait until these things are in the indices and so they won’t buy them and benefit from the premium.’
#3. Moving targets
Similarly, Pacquement added, indices are unable to move dynamically as the market does. This means crossover credits and fallen angels immediately fall out of their scope of interest. ‘In fixed income you are also looking at market segmentation which creates inefficiencies as well, such as the distinction between investment grade and high yield.
‘We have got names we play regularly as they have moved from one to another, we have had Ericsson, Siemens, for example, and on the way up we have had names fall down as well, so these are ways we can play it on the way up.’
#4. Home bias
In her final point, Pacquement said investors can be driven by regulators to focus on their domestic markets and this is something those with a global remit can capitalise on. ‘Investors will have regulatory reasons to stay within their country of origin or currency which also creates inefficiencies we can play as active managers. Now we are seeing issuers access the global markets and global capital markets which also gives us something to play with as active managers.’