Roundtable – Fallen angels

green. In high yield you find private equi- ty-owned firms focusing on green trans- actions. The cynic in me thinks that they are after tighter spreads. If you get a rigor- ous groom judging these ESG standards, you may be in a more difficult situation than you would be with a vanilla bond. Hayes: ESG is important. Clients demand it. Environmental, social and governance issues are highly relevant in today’s mar- kets, but they do not heavily influence a rating agency downgrade. Rating agencies are traditional. They look at fundamental balance sheet informa- tion, leverage metrics and cashflows. Hopefully, at some point ESG becomes more relevant to rating agencies, but today if bonds are downgraded, it is based on the traditional metrics. Weeks: Rating agencies are creeping high up on the agenda for trustees to get accu- rate data. The E tends to be top of the list. G is creeping up, with Tesco’s accounting problems an example of why. Tobacco is high on people’s agenda. With the number of smokers gradually reduc- ing, is this a good time to bail out? But on the other hand, the dividends are good. Trustees deciding when to pull the plug is the issue. Kwatra: It is about balance. You have to pay attention to the rating agency, but that is no replacement for scrutinising the asset yourself. There is an onus on the investors to understand what is driving the fundamentals: why has it been down- graded and what are the prospects for a reversal?

As a buy-and-hold investor, we get scrutiny from the regulator not just to align what our rating agency says, but to form our own internal view and essentially own the risk. Visavadia: Rating agencies are important. As an investor you want to take as much information from the market as possible. Rating agencies focus more on a quantita- tive assessment, but there are a lot of other commentaries out there, like fund manager reports and consultants who

46 | portfolio institutional | April 2021 | issue 102

If 2021 rhymes with the past, we are in a good period to invest in fallen angels.

Manuel Hayes, Mellon

more relevant, accessible and easier to digest, but they do lag. We have looked at the analysis of all fallen angels as they have been downgraded in the past 15 years. What has become obvi- ous is that even six months before a down- grade from investment grade to high yield, you will see the market pricing it in. The market is more efficient, understands information, is faster moving and easier to digest. You will see under performance of these investment grade bonds as they start slowly getting migrated, the market sees it and prices that in. To that degree, the market is more effi- cient than the rating agencies. I am not saying they are bad, just slower moving.

provide opinions. We pay attention to rat- ing agencies, but we listen to other people at the same time. No one person is going to tell you the full story. It makes the life of a trustee more difficult, but it is the right thing to do. Hollis: You could do research forever and you would never be finished. Not even a CFO has perfect knowledge of his compa- ny’s finances. There is a point where you have to say that further effort is not going to be rewarded with further information and draw a line. It is knowing when you have answered your questions, and identified the potholes, then you rely on your judg- ment and monitor it to see if you are right. Trow: Generally, people are more comfort- able with investment grade because it is more homogeneous. If you get a far more dispersal around mean credit spreads in high yield, it is an opportunity if you do the relative value and fundamental work to see if the apparent relative value is real or not. Effectively, rating agencies create the fallen angel arbitrage. Hayes: This is something, especially in the investment grade universe, that lags. It has improved over the years, their met- rics are getting better as data is becoming

PI: How are you accessing liquidity in this market, Manuel? Hayes: Liquidity has never been better in the fixed income markets, but it depends on how you access it, where these pockets of liquidity are and how you curate it. Traditionally, fixed income has been illiq- uid, especially in high yield. You phoned your broker 10 years ago and were trading by

appointment, but the market has evolved.

The growth of ETFs has been the catalyst that bridges the gap between the great liquidity you see in the equity markets and the fixed income markets. They are not on the same level, but it is evolving, getting better – and that is exciting if you know how to access it. That is a big if. People still call brokers and there will be a need for that. They have the balance sheet and can make markets on specific bonds, but there is a larger ETF ecosystem that is being built into the fixed income markets. If you can access it, you could buy bonds cheaper and do it in size and scale. Weeks: Trustees are aware of the need for money for transfers. They will also be aware of the risk of getting out of invest- ments if a fire sale is necessary, so liquid- ity is high on their list. Visavadia: How much of an issue is liquidity? There is so much money being

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