At a high level it is possible to decompose the return drivers of global investment grade corporate bonds into six areas: rates; geographic regions; currency exposures; credit ratings; industries/sectors; and issuers and issues.
For Capital Group, this diversity implies more potential sources of total returns as well as alpha/excess returns over a market cycle.
Rates
Based on the market/currency in which bond issuance occurs, the universe comprises around 80% North America and 20% Europe[1]. However, the individual markets’ rate structures vary considerably, being much longer (in terms of years duration) in the UK and US than elsewhere, so we focus on duration-weighted market exposures when looking at our portfolios.
Insights from our Portfolio Strategy Group, and our global rates and economics teams, lead periodically to tightly controlled active rates exposures. However, we believe that our fundamental bottom-up credit decisions, rather than non-credit factors, should drive portfolio excess returns. Therefore, we closely monitor various duration metrics, such as portfolio duration, active duration (i.e. duration versus the index) and key rate duration (i.e. rate sensitivity around key nodes along the yield curve).
Geographic regions
By geography, issuers from 57 countries have bonds outstanding in the global investment grade corporate bond space, with US-domiciled issuers accounting for around half1. Given Capital Group’s focus on fundamental bottom-up analysis and issuer valuations, our strategy weightings to different countries by issuer domicile tend to be the result of an aggregation of securities we favour.
However, our macroeconomic and political research team does give context to our analysts’ decision-making. Having a deep well-established, extensive global footprint is key to covering this diversity of geographies.
Currency exposures
Currency movements often dominate bond returns, so global corporate bond portfolios tend to be FX hedged.
Indeed, given our preference for fundamental bottom-up credit decisions to drive excess returns, we fully hedge bond exposures back to USD, and do not undertake any active FX overlays.
Credit ratings
At least one of the big three ratings agencies (S&P, Moody’s and Fitch) assigns a credit rating to virtually every bond issue. However, given our focus on fundamental bottom-up analysis and issuer valuations, our weightings to different credit rating bands are primarily the result of an aggregation of securities where we have high conviction. That said, rating bands remain important from a valuation perspective.
Industries / sectors
Within corporate bonds, there are three broad industry categories – industrials, financials and utilities. There are also numerous sectors, which can be further divided into sub-sectors. This means that we can potentially add a great deal of value, as our analysts are sector-aligned and specialists in their domains.
As well as undertaking desk-based research and analysis, attending industry conferences and making company visits, they also actively engage with their other sector counterparts in the high yield and equity teams. Sectors that are not in the index – such as government securities (primarily US Treasuries), government-related securities (often government-owned banks and utilities) and cash – also help with excess return generation.
Issuers and issues
There are 2,500 corporate issuers, and 12,500 distinct bond issues[1], in global corporate bond market indices. This is where we look to add most value consistently over the cycle.
Our analysts spend most of their time researching individual issuers and can also leverage their equity team counterparts’ parallel research.
How is Capital Group Global Corporate Bond Fund (LUX) positioned for the current market environment?
The COVID-19 crisis caused heightened volatility in corporate bond markets, including a sharp sell-off in March. This led to an unprecedented level of support from central banks and governments, including the purchase of US corporate bonds by the Federal Reserve for the first time. While economies have gradually reopened, uncertainty and risks remain.
While we adopt a long-term approach, this does not necessarily mean that we will always hold only a set of high conviction positions for a long period of time and simply ‘ride out’ volatility with low turnover. Our investment teams are very comfortable taking advantage of market dislocations, which is exactly what they have done recently. For example, our analysts took advantage of the new issues in March that came to the market at attractive spreads.
The portfolio is currently slightly overweight energy, but with a significant proportion of that concentrated in high-quality issuers and shorter dated paper. Portfolio managers have, however, been selectively adding to BBB-rated high conviction views in that space over the past few months as markets stabilised. But a lot of uncertainty remains, and the portfolio continues to emphasise sectors that are likely to continue to do well in a potentially volatile market environment. For instance, we are overweight utilities.
Developments related to COVID-19 continue to be a key driver of investor sentiment and are likely to result in renewed market volatility, at least in the near to medium term. Therefore, we believe it is imperative to maintain a balanced and diversified approach, with a strong focus on active fundamental research: this plays to Capital Group’s core strength. In the current market environment, dispersion across sectors and bottom-up security selection are more important than ever.
Past results are not a guarantee of future results.
[1] As at 31 December 2019. Source: Bloomberg
[2] Data as at 28 May 2020 based on the Bloomberg Barclays Global Aggregate Corporate Index. Source: Bloomberg
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