If you don’t like commodity producers, loans have another advantage over high yield: while the latter has a 15% exposure to commodities, it is only 3% for loans. Gadsby believes that is a good thing.
“The average energy issuer now funds itself at a spread of 400bps after a strong rally in past 12 months. This is the same level as 2014 when the oil price was at $75. Oil is now at $50. This means oil companies have either cut $25 per barrel in costs to justify a 400bps spread at this price level, or the spread compression has gone too far. I suspect it is the latter.”
Though interest in direct lending strategies is growing fast, it is difficult to access for non-institutional investors. All of Sckerl’s clients are from the institutional space, mainly pension funds and insurance companies, that typically invest through mandates. But Gadsby is planning to make loans more accessible to other types of investors.
“Credit Suisse AM is in the subscription period of the first ever fixed-maturity loan fund,” he says. “It is an ideal vehicle for investors who are new to this area.”
The fund could essentially be compared to a bank deposit with a higher yield (4.5% yield-to-worst) and a BB-risk exposure, with a focus on US issuers. However, since the fund cannot be wrapped in a Ucits format, it will only be accessible to qualified investors.
Home advantage
Investing in mortgages is another way to diversify a fixed-income portfolio. Although commonplace in the US, it is relatively new in Europe, where the process of disintermediation has only just started.
Dutch pension funds are among the first movers here. The Dutch Mortgage Funding Company (DMFCO), which is AIFM-licensed, provides mortgages to home buyers using pension fund money. It has accumulated a mortgage portfolio worth between €9-10bn since its launch in 2014. This is a tiny proportion of the €662bn Dutch mortgage market, according to the Dutch central bank DNB.
Pension fund market share is growing fast, with 11% of new mortgages financed by pension funds in 2016.
Dutch pension funds have been keen to engage because mortgages target an excess return of 200bps. They also have low credit risk, a long duration and stable cashflows, making them ideal instruments for liability-hedging portfolios, says DMFCO CEO, Jeroen van Hessen.
“Therefore, pension funds and life insurers are our natural clients. But we are currently also speaking with some big insurers and banks from the UK and the Nordics.”
Investing in mortgages is not the exclusive territory for institutional investors. However, investors will need to look to the US for sufficiently liquid opportunities.
Only a couple of funds are available in Ucits format, offering access to the mortgage-backed securities market. One is the BNP Paribas Flexi I US Mortgage Fund, which offers daily liquidity. It has grown from $200m at the start of 2016 to roughly $1.3bn.
“Investors struggling to find competitive returns in fixed income are now turning to us,” says Julian Kramer, head of external distribution, northern Europe at BNP IP.
But weren’t mortgage-backed securities at the root of the global financial crisis?
“You have to distinguish between mortgages with the backing of one of the big mortgage agencies, such as Fannie Mae and Freddie Mac, which have strict eligibility requirements like stable employment and a down payment of 20% or mortgage insurance, and non-agency loans,” says John Carey, manager of the Flexi I US Mortgage Fund, which has invested over 90% of its assets in agency-backed loans.
