The investment process of investing in corporate bonds is very similar to the one that applies to invest in equities. However, there are a number of additional considerations. At Formuepleje, the credit team follows a carefully defined process and some very specific criteria.
What do you prefer? Investing in a South European bank’s bonds or in bonds issued by a US automaker? Both can be good investments, but also the opposite. The wealth management corporate bond team also called the credit team, has a rigorous selection and analysis procedure designed to find low-risk, low-risk bonds.
Overall, the team invests in two different categories of corporate bonds: Global High Yield and Emerging Market Bonds. Global High Yield bonds are bonds with a rating that is not good enough to be designated as an Investment Grade. That is, bonds that have a credit rating of between Baa3 / BBB and down to B-. Thus, no investments are made in bonds with a CCC rating or lower.
The investment interesting for this group is that the risk of bankruptcy is small, while the expected return is good. That is about 5-6 percent after costs. The bonds selected by the team often have the potential for a better rating, which increases the value of the bonds over time.
The second category of corporate bonds is the so-called Emerging Market corporate bonds. That is, bonds issued in emerging markets such as Indonesia, Colombia, Mexico, Turkey, and the Philippines. Investments are made in bonds issued by companies with a credit rating above or equal to B-.
That is, also in the higher rated Investment Grade bonds. In terms of investment, these are companies that need financing and that operate in countries with growth. It opens up attractive investments with an expected return of between 5-6 percent after costs. Since the bonds are often issued in US dollars, predominant hedging of the currency risk is made against the euro or Danish kroner.
The starting point for the selection within both categories is a key figure-based screening of the entire universe of corporate bonds, which currently has approximately 8,000 to choose from. It is called a “bottom-up” approach, which initially does not focus on countries and sectors. The 8,000 bonds are reduced to approximately 400 by discarding certain high-risk countries and sectors such as energy or commodities. Furthermore, there may be special wishes for maturity – as well as minimum rating requirements, where the team, as mentioned, does not invest in bonds that have a rating under B-.
The next phase is to look at the various key figures for the relationship between debt and equities, earnings and cash flow, and to focus on reducing debt.
“We want to invest in companies that have a solid balance coupled with the ability to reduce debt. In continuation of this, it is important that the company does not enrich the shareholders through dividends and share buy-backs at the expense of the creditors. The company must have a policy for developing its capital structure, which takes care of debt care with the clear aim of keeping it calm or down, “says Klaus Blaabjerg.
Then there is a list of perhaps 200 bonds plus a list of previously selected bonds. For these, the team conducts business analysis and thus draws on the same tools that a stock analyst would do. That is, they look at the company’s accounts, products, management, market position, and in addition, they sometimes visit the company and talk to management.
In addition, the team must conduct a careful bond analysis and calculate the value that they think the bond has. This work includes a concentrated reading of the prospectus that follows the bond. There are often hundreds of pages in English in a legal and financial language.
“It is important to know all the details. The bonds often have some special provisions. For example, if the company is taken over. If there is a change of ownership clause attached to the bond, the investor will be able to sell the bond at a price of 101. For example, banks often have rules on how the bond debt is included in the calculation of the capital base for the bank, and if that changes, the bonds can suddenly become less valuable, requiring experience and deep knowledge to be able to understand and assess these risks. ” Klaus Blaabjerg says.
In order for the bond to enter the portfolios, it requires the team to calculate a fair value that is higher than the actual value that the bond can be purchased for. The calculation of this value includes an assessment of the company’s creditworthiness. Here it can play in if the team believes that the company is more creditworthy than the large rating agencies believe.
There may be a hidden price gain if a corporate bond gets a new and better credit rating. The task of the team is, among other things, to identify these upgrade candidates and invest in them before the rating is raised. Thus, a good price gain is often achieved.
In addition to the entire micro-analysis of the individual company and bond, the team also attaches importance to incorporating analyzes of the country or sector itself.
“We must take into account the country in which the bond is issued, as there may be specific political risks that may affect the price level, for example, we saw last year in Russia. In addition, there are some sectors that we periodically try to avoid. “Currently, we are very cautious about companies in the energy sector, as the oil price has been pushed very far down. This has particularly affected Norway and the US,” says Klaus Blaabjerg.
Once the bond has been added to the portfolio, the team must continuously monitor the portfolio and sell out of the bonds that have risen to or above the calculated fair value. In addition, the team must keep abreast of developments in the market and in the individual companies in order to be able to sell out in time, if there are danger signals.
“The ongoing monitoring is very important. We would like to avoid having bonds that go bankrupt. It is important to remember that when investing in corporate bonds, an ongoing return that has a natural limit is not. to invest in shares where the price can easily double, “says Klaus Blaabjerg.