Schroders has $30bn under management in fixed income, of which roughly $2 billion is managed in Asia from offices in Hong Kong, Tokyo and Singapore. Michele, its London-based head of fixed income is responsible for the firm's strategic direction and budget allocation. He discusses why he has decided to open up the purse strings to Asian corporates and why he's prepared to move down the credit spectrum to find value.
FinanceAsia: Which deals did you like this year and why?
Michele: One of the main issues with us is that we've been negative on corporate credit for quite some time. We felt that the global economy was pretty weak and there had to be considerable central bank ease to stimulate growth, so we've actually not been big participants in the credit market. That's now changed. We were pretty aggressive in the SingTel deal and there were two things we liked about it. One was the pricing. In our mind, it came very cheaply because it was one of the first issuers out of the gate at a time when the central banks had eased by a surprising degree. You'll recall that it came the week after the Bank of England, the European Central Bank and the Fed eased by 50bp. The message we picked up was that policy makers weren't going to allow a global recession or a deepening of the global slowdown. That changed our opinion on credit and we had to become buyers.
You said there were two reasons. What was the second?
The second one was that it was a fairly sizeable deal and we don't want to buy illiquid, smaller issues that are only about $100 million in size. We want to buy offerings that have size and dealer sponsorship.
Some believe the deal was priced too cheaply. As the leads kept bringing the indicative pricing down, was there a point where you would you have said no, this is the cut off point for us?
Certainly there would have been a point, but you have to consider that investors, including ourselves, had gotten very underweight credit. There wasn't a whole lot of available paper out there. It was clear there wasn't enough supply to satisfy demand and if you looked at a lot of other telecom issuers in euros, such as Deutsche Telekom and Telecom Italia, they've now tightened close to 60bp to 70bp.
Over what space of time?
In the last four weeks and since SingTel's come, they've tightened another 30bp. I'll also say I think it was smart of the syndicate to price it cheap to fair, because this ensured the deal went well and it pretty much opened up the gates for issuance globally. We still own SingTel and we think it can come in by another 25bp or so.
Are you here to stay, or was participation in SingTel a one-off? What kinds of opportunities are you looking for now?
I think we're here to stay and we look at things in cycles. The widening in credit spreads has been pretty severe. Credit spreads started out the year cheap and they've now become even cheaper as a pretty good recession has been priced into the market. When you think about a global recession, the regions to be worried about most are those that are export-oriented and of course Asia is a big exporter. And I think that's accounted for the general aversion to participating in Asian credit. There are two things that have turned our opinion on Asian credits and we now like them more so than European and US credits.
One is that the degree of central bank ease seems to be helping. It's been extreme. You've had 450bp out of the Fed, but now retail sales and other leading indicators seem to have turned around. The US stock market has also generally improved. The wealth effect is not what it was previously, but there was a feeling there might be a negative wealth effect and that's not the case. Our economists expect a rebound in the US during the second quarter of 2002, which pretty much confirms that there's a V forming and that the fourth quarter of 2001 is the bottom of the V.
The second issue is oil and Asia is a big importer. This negative has also reversed itself. Before there was weak demand for export oriented Asian economies and the one import had dramatically risen in price. These two things have reversed and what's left is a pretty cheap corporate bond market.
A lot of people argue that Asian bonds are not cheap relative to their rating, because the Asian bid has tightened them out of all proportion.
I disagree with that. In the US, there are still a lot of companies with capacity issues. The US corporate bond market is cheap, but it still needs to feel a bottom and one issue we're looking at quite closely is what's going to happen with the three main auto manufacturers - Ford, General Motors Daimler Chrysler. They're all rated triple-B by S&P and single-A by Moody's. In the current environment, it's unlikely their financial ratios can maintain a single-A rating, but should they be downgraded to triple-B, I think it would be a pretty severe problem for the US corporate bond market resulting in forced selling. So in the US, there are structural issues, which don't seem to really exist in Asia. The European corporate bond market looks a little bit richer than the US, but it's being supported by the creation of the euro and demand for euro-denominated credit.
Is your demand Asia wide or country specific? Do you think, for example, that the whole Korean credit universe is too tight?
Well frankly, it's going to reside more on the corporate than the sovereign side. All I can say is that if you include sovereigns as part of the overall universe, then yes, you might look at Korea and decide that it's pretty pricey.
So you'd rather invest in a Kia Motor rather than a KDB or a Kexim?
Yes, because that's where the value resides. I think you have to go outside the sovereign and agency market and I think you also need to build in some kind of yield cushion. Since the equity markets seem to have recovered from their post 9/11 lows and global government bond yields have started to rise, that confirms a bottoming and there's not a whole lot of cushion to withstand a sustained rise in interest rates. It seems that where an investor wants to be now is in bonds that didn't necessarily go up in price and down in yield.
Do you think there's likely to be a big pipeline of Asian corporate issuers? It always seems to take a long time to persuade corporates in this region to come to the international dollar markets and most that have, have been simply terming out bank debt.
That's actually something we've talked about internally. When you look at a lot of re-financing then you're right, much of it is just terming out bank debt. But the reality is that it's always been a two-step mechanism. When rates drop to extreme levels companies tend to refinance bank debt and tender for existing debt, which then provides them with a little bit of a cushion. But once consumers start to re-liquify themselves and then start spending, corporates will start borrow for capex..
Since the Asian financial crisis, the domestic bond markets have provided a lot more competition for the international markets. There's also a horror here of being overextended in foreign currency debt and issuers would rather have a maturity mismatch rather go to the dollar markets for longer-term funding.
As an investor in Asian debt during 1997 and 1998, I can attest to the extreme pain and unhappiness that non-US domiciled issuers can extract. But the reality is that investors have become more global in the interim period and learned from those mistakes. There will be a lot of issuers that won't be able to come to the international market, but personally I think investors now have a better understanding of how to include non-US issuers in a portfolio.
So how have you increased your Asian weighting?
In a unconstrained global bond portfolio, we want to increase our Asian weighting from 2% to 5% by end of the second quarter. A lot of this is going to be in credit. As you point out, the interest rate environment is a lot lower here than in US and Europe, so it's important for us to try and look for value, because declining government yields are a thing of the past. It's what's left behind that's important.
Do you have a ratings threshold?
No. Single-A issuers that come at a pretty attractive spread can be bought pretty widely across all $30 billion dollars of assets, but where we run more aggressive portfolios, we're looking for stories with exceptionally high yields. We've been one-and-a-half-times overweight governments and if you look at global aggregate benchmarks we've been 10% in corporates, which is about two thirds of benchmark weighting. When we're done, we should be up to about 30% to 35%.
And how do you run your Asian funds?
All the regional offices contribute to the various global bond products whether it be pure investment grade debt or emerging market debt. Rather than have three people in London managing the product, we'd rather have the Asian bond group give their input on what should be held. Something like SingTel, for example, could be purchased by Hong Kong, Singapore or London and be placed across 15 different portfolios.
Would you say that you're ahead of the curve in being so bullish on Asia?
I think we're at the front edge of it. There's still an awful lot of denial that credit is good. You infer that corporates here have performed well. Because the sovereign issues have done well, there may not be a whole lot of value in this market sector. But when investors see that there is corporate issuance and that it is relatively cheap, there will be an awful lot of buying. We'd rather be in the consensus as it's forming rather than after the fact.
And where are you most bullish?
It has to be China. There seems to be a pretty significant fundraising requirement from that country and we believe next year will be a big one for issuance. I also think that we'll be seeing both public and private deals. By that I mean that not all will be rated.
