7 Alpha-Boosting Strategies for Your Fixed Income Portfolio
If the last two years have taught investors anything, it’s just how sensitive most asset classes are to interest rate changes. In navigating a myriad of unknown variables, accurately predicting the macro landscape has proven challenging in recent years. Therefore, we believe the current environment presents an excellent opportunity to invest in alternative strategies that focus on generating alpha.
Picton Mahoney’s (PMAM) fixed income team has identified these seven alpha themes for 2024 that they believe can make a positive difference.
This type of strategy generally aims to identify and capitalize on credit issuers undergoing significant changes such as M&As, spinoffs or capital allocation shifts.
With inflation stabilizing and interest rate cuts on the horizon, our team is now seeing a resurgence in M&A deals, creating potential for uncorrelated double-digit returns in these event-driven credit refinancing situations.
Usually issued by pipeline and utility companies to fund specific projects, hybrid debt is a part of the capital structure that is below senior debt, but above common equity.
While credit spreads at the index level look expensive, this particular segment of the credit market continues to trade at close to historically wide spreads. We are now seeing an appealing risk/reward dynamic in some high-quality issuers offering yields exceeding 8%.
These are low dollar-price bonds where we believe the issuer will refinance or redeem them prior to maturity (for example a company might opt for refinancing when the bond first becomes callable at par as opposed to later).
We believe that having a view on a bond’s call date can have a dramatic impact on the potential yield, i.e. YTV. By pinpointing this opportunity through analysis and engagement, we aim to capitalize on these kinds of mispriced opportunities.
Rate-reset preferred shares are issued at a fixed spread to a benchmark like the Government of Canada five-year rate. After five years, the coupon resets to the new prevailing five-year rate unless it is redeemed by the issuer.
While we typically don’t participate in the preferred share market due to its inherent volatility, we do allocate tactically when compelling opportunities arise. Last year’s volatility in the preferred share market gave rise to an opportunity to invest in higher reset preferred shares that were trading at a significant discount.
This opportunity includes additional Tier 1 bonds (AT1s), Limited Recourse Capital Notes (LRCNs), and Credit Risk Transfer securities (CRTs) with asymmetrical risk/reward potential.
As regulators boost work to strengthen the banking system through rising capital requirements, major banks have responded with creative strategies including a boost in issuance of these unconventional capital securities. Our team has been strategically investing in this trend.
With the easy money era now behind us, poor performing and over-levered companies will likely struggle to refinance their existing bonds at maturity.
Shorting these bonds can serve as a portfolio hedge against our long positions and also presents a potential source of alpha. Unlike traditional long-only managers, our team is able to capitalize on deteriorating credits by strategically leveraging the short side for alpha generation.
Using derivatives to hedge rate and credit risks has been a critical tool to help our investors navigate volatile market environments.
With credit spreads hovering near historical lows, we see an incredible opportunity to hedge and potentially profit from widening spreads in 2024.
This material has been published by Picton Mahoney Asset Management (“PMAM”) on April 25, 2024
It is provided as a general source of information, is subject to change without notification and should not be construed as investment advice. This material should not be relied upon for any investment decision and is not a recommendation, solicitation or offering of any security in any jurisdiction. The information contained in this material has been obtained from sources believed reliable, however, the accuracy and/or completeness of the information is not guaranteed by PMAM, nor does PMAM assume any responsibility or liability whatsoever. All investments involve risk and may lose value. This information is not intended to provide financial, investment, tax, legal or accounting advice specific to any person, and should not be relied upon in that regard. Tax, investment and all other decisions should be made, as appropriate, only with guidance from a qualified professional.
This material contains “forward-looking information” that is not purely historical in nature. These forward-looking statements are based upon the reasonable beliefs, expectations, estimates and projections of PMAM as of the date they are made. PMAM assumes no duty, and does not undertake, to update any forward-looking statement. Forward-looking statements are not guarantees of future performance, are subject to numerous assumptions, and involve inherent risks and uncertainties about general economic factors which change over time. There is no guarantee that any forward-looking statements will come to pass. We caution you not to place undue reliance on these statements as a number of important factors could cause actual events or results to differ materially from those expressed or implied in any forward-looking statement made.
There is no guarantee that a hedging strategy will be effective or achieve its intended effect. The use of derivatives or short selling carries several risks which may restrict a strategy in realizing its profits, limiting its losses, or, which cause a strategy to realize or magnify losses. There may be additional costs and expenses associated with the use of derivatives and short selling in a hedging strategy.
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