Can you please provide a brief overview of the strategy in terms of what we are trying to achieve for investors, our investment process and the make-up of the investment team?
The strategy invests in senior secured bonds of companies that primarily have a below investment-grade credit rating. Senior secured bonds reside at the top of a company's capital structure, ranking ahead of subordinated debt and equity instruments, and are also backed by issuer collateral or some form of assets, which can range from tangible assets such as real estate to intangible items like trademarks. Ultimately, this means that if a company defaults, senior secured bondholders are prioritized in the payment structure and repaid ahead of junior bondholders, which has historically resulted in higher recovery rates.
Barings has been a pioneer investor in this market, with a more than 11-year dedicated track record of consistently outperforming the benchmark, both on a total return and risk-adjusted return basis. This is a well-established market, which stands in excess of $560 billion*, and provides active managers such as Barings a rich opportunity set for sustainable alpha generation.
This strategy enables investors to allocate to a market that provides compelling income and yield prospects, while benefitting from greater principal protection. The strategy's focus is primarily on North American and European issuers.
It is our belief that when investing in high yield credits there is no shortcut for in-depth credit work and methodical and detailed monitoring of companies. Through rigorous fundamental credit research, we aim to minimize principal losses and identify selective opportunities for capital appreciation over time. We have one of the industry's largest dedicated global teams, with over 60** U.S. and European high yield investment professionals. We also actively collaborate with our Special Situations group, which is an important resource for this strategy. This scale allows us to conduct detailed, bottom-up analysis of company financials, integrate ESG factors into our credit assessment and to actively engage with company management to identify attractive opportunities.
*Face value as of 31 March 2022 as measured by the ICE BofA BB-B Global High Yield Secured Bond Index
**Source: Barings, as of 31 March 2022
How are we positioning the portfolio in uncertain times?
The market environment thus far in 2022 has been extremely challenging, with rising interest rates, elevated inflationary pressures, Russia's invasion of Ukraine and on-going COVID related disruptions weighing on market sentiment. Given the market uncertainties at play, we continue to manage the strategy in a highly active manner, with strong emphasis on bottom-up security selection. Ultimately, when it comes to mitigating credit risk and uncovering relative value opportunities, we believe analysing the underlying credit fundamentals is of paramount importance. At present, we are also paying close attention to companies' sensitivity to higher inflation, including the ability to pass on higher input costs onto their end consumers and resilience to supply chain disruptions.
One of the potential benefits of the strategy in the current environment is the relatively lower interest rate sensitivity profile relative to most fixed income asset classes. Indeed, this has been one of the key factors that has resulted in the senior secured bond market outperforming the broader high yield and investment grade bond markets in 2022. Our recent positioning has favoured shorter maturity bonds with higher coupon and spread levels, which have generally been more resilient to rising interest rate expectations relative to the broader market.
Can you identify a couple of key investment opportunities for the fund, that you are playing at the moment in the portfolio? This could be at a stock, sector or thematic level.
From a credit fundamental standpoint, despite some of the recent negative macroeconomic developments, North American and European high yield companies remain on sound footing, with leverage levels coming down, interest coverage ratios increasing and with companies sitting on ample liquidity reserves. Given the significant amount of debt re-financing that has taken place since the onset of COVID, debt maturity walls have been pushed out, reducing solvency risks. As a result, default rates have been extremely muted and should continue to remain relatively contained moving forward. Despite this robust credit fundamental backdrop, we have seen yields rise considerably since the start of 2022 and exceeding 7% levels, largely driven by rising interest rate expectations. This material re-pricing across the senior secured bond market provides some compelling investment opportunities.
Another area where we have been seeing some opportunities is in some of the more COVID impacted credits and sectors. While uncertainties remain, some of these holdings are well positioned to benefit from the ongoing reopening taking place across developed markets in particular, and in fact we have seen sectors such as Travel and Leisure, which continue to benefit from pent up consumer demand, performing relatively better in recent periods.
This post is sponsored by Barings