IG dollar bonds with RMB exposure generate best alpha: Stratton Street
UK-based hedge fund Stratton Street sees value in buying US dollar bonds from Asian countries with high net finances to GDP, using an NDF to add renminbi exposure, the firm tells Asiamoney, a sister publication of EuromoneyFXNews
Stratton Street’s Renminbi Bond Fund has generated 23% in returns to end-October by investing in dollar bonds from Asian countries with net foreign assets (NFA) of more than 50% of GDP, and using non-deliverable forwards (NDF) to add 100% exposure to the renminbi. The renminbi will continue to appreciate by 2% to 3% each year, but yields will remain low as banks in the region continue to deleverage their balance sheets and high yield bond spreads will compress while high yield credits will struggle, according to Andrew Main, managing partner of the UK based hedge fund.
"We start off with a portfolio of dollar bonds and attached to that we add an NDF which gives us the currency exposure. It’s dollar versus renminbi and we don’t speculate on that.We match the NDF to the portfolio, so if it’s US$100 million portfolio, it’s US$100 million currency exposure," he said in an interview with Asiamoney PLUS on November 29.
His strategy has remained the same throughout the last five years. He doesn’t speculate on the currency, arguing that it adds to the risk his fund will underperform, and investors don’t like surprises. He takes relatively short-term positions, usually one month at the longest, and he doesn’t follow indices.
"We’re not index followers at all. We look for deep value in wealthy countries. Those are countries that have very high net finances to GDP. We call it a seven star system. It’s like a hotel, you want to stay in the seven star rooms. The one star flea-pits are the ones you never want to go into."
His definition of Asia includes Russia as well as the Middle East, and his seven star countries include Hong Kong, Singapore, Taiwan, Malaysia, Japan and China. He argues there is no value in buying bonds from places such as Vietnam, Indonesia and the Philippines. When asked whether he ever found this model limiting, he said he did not.
"We currently are buying, for instance, IPIC [International Petroleum Investment Company] in Abu Dhabi at roughly 100 basis points greater than the Philippines. IPIC is ‘AA’ rated and the Philippines is not. So from a relative value point of view, we’d rather own IPIC," he said.
"In three years if that turns the other way, we’d be very happy to do the trade. As I said, we’re not looking to follow an index, we’re looking to create value. We don’t think the indexes are correctly weighted."
The fund, as a general rule, only invests in bonds rated ‘BBB’ or above, as Stratton Street’s house view is that we are still in a deleveraging world, with trade and business development slowing down.
"That is likely to put strain on the balance sheets of some of the weaker companies. And we do not believe that the spread pickup you can get for going into those low grade credits merits the risk. We would rather be in ‘AA’ and ‘A’ credits at this time, just where we are with the cycle," said Main.
He argued, in addition, that due to a large-scale deleveraging of balance sheets, people around the world with cash are looking for places that offer relatively high returns, which results in a rerating of a lot of the international offshore dollar credits.
"What I think will happen is, as in Japan, you’ve had a number of years out in the wilderness and credit spreads will continue to tighten. That will happen in the higher rated bonds, but the weaker credits, higher yielding credits, will bifurcate.There are quite a lot of ‘BB’ corporates out of China but the appetite there is going to dissipate."
His approach, therefore, is to look for value by comparing, for example, ‘BBB’ rated bonds, for relative value against the treasury curve.
"Technically how we do it is put five and a half thousand bonds into a machine. If we find a ‘BBB’ bond that is 20 or 30 basis points cheap and looks like a ‘BB’ rather than a ‘BBB’ then, all things being equal, we’ll add it to our portfolio until it can be replaced with something cheaper," he said.
The turnover of the portfolio is around 14%-15% per year and in many cases the bonds are held to maturity. In terms of tenors held in the fund, this varies according to the hedge fund’s macro view.
"[At the moment] we like the long-term. We don’t think the world is suddenly going to leap back into life next year. We don’t think it’s going to fall apart, but we think it’s going to grow at 1% or 2%, not 5% or 6%," said Main.