For Lombard Odier it is time to invest in the 5Bs. For the Swiss management company, today the opportunities in the corporate bond world are found in bonds with ratings between BBB and BB, i.e. companies located between the lowest part of the investment grade segment, also called fallen angels, and the highest part of the high yield, known as rising stars. Especially in a crisis situation, the high yield world exposes us to a situation where different defaults are expected, while investment grade yields little and sees forced sales triggered on those securities that are downgraded, which are thus inherited from the BBB rating area -BB.
“The potential of the BBB-BB segment is underestimated – said Stephane Monier, Deputy Global CIO of Lombard Odier Investment Managers who has just launched a bond fund in the segment, LO Funds Global BBB-BB – Historical data, in fact, show that the risk-adjusted performance of this universe, between 2003 and 2011, was 25% higher than the investment grade sector and even 55% higher than high yield. And if we add to this that the maximum risk of loss seen so far in the crossover segment is around 15%, compared to 31% in high yield, the opportunities are clear. The last elements to consider are the size of the market and the number of issuers: the crossover segment has a global capitalization of 2.900 billion dollars compared to 1.610 billion of high yield”.
THE BENCHMARK BASED ON FUNDAMENTALS
The fund is managed by adopting a proprietary index based on the fundamentals of issuers (fundamentally weighted benchmark) as a benchmark and therefore differs from traditional bond funds which, using indexes based on capitalization, tend to give greater weight to companies, countries and sectors characterized by from a higher level of debt. The fundamental benchmarks of Lombard Odier IM, on the other hand, considering objective factors such as macro indicators, creditworthiness and socio-demographic variables, attribute greater weight to issuers with the best prospects of repaying their debt. “The debt crisis – Monier explained – has made evident the limits of the dominant approach in bond management where the reference point is given by indices based on market capitalization and ratings. This approach tends to assign a greater weight to more indebted countries and companies, while common sense would instead suggest reducing exposure to these issuers since as their debt increases, the risk of partial or total bankruptcy also increases”. In particular, for corporate bonds, the process adopted for the construction of the fundamental indices is divided into three phases. At first, the geographic weight is defined for four currency areas (Europe, USA, UK and Japan) based on liquidity, yield and contribution to global GDP. Then, within each area, the weight at the level of each industry is calculated based on its contribution to the area's GDP, performance and liquidity. Subsequently, each issuer is analyzed on the basis of five factors: turnover, leverage (net debt / Ebitdar ratio), interest coverage ratio (fixed interest expenses / Ebitdar ratio), operating cash flow to total debt and finally the level of earnings growth relative to the level of debt. For banks, in addition to turnover and leverage, the other criteria differ given the specificity of the sector.
THE LO FUNDS GLOBAL GOVERNMENT
Along with LO Funds Global BBB-BB (managed by Kevin Corrigan), Lombard Odier has also launched LO Funds Global Government, a government bond fund that invests in OECD countries (managed by Gregor McIntosh). Here too a proprietary index based on the fundamentals of the issuers (fundamentally weighted benchmark) is adopted as a benchmark which takes into consideration three macro indicators: economic factors (size and growth of GDP), creditworthiness (public debt/GDP, private debt/GDP , debt held abroad/GDP, deficit/GDP and current account/GDP) and finally socio-demographic variables (population aging and misery index). The weight of each issuer is therefore determined on the basis of the score attributed to each evaluation factor.
