At Loomis Sayles, we add value as MAC investment managers by being focused on top-down regime identification, seeking to maximize risk-adjusted return potential within these credit sectors. This paper outlines key elements of our process.
Global Credit Cycle
At any time, regions, countries and sectors around the world are in different phases of the credit cycle—presenting potential credit opportunities for investors. To determine opportunities, credit cycle analysis reveals which economies are borrowing and spending, and which are saving and deleveraging. This step, along with the characteristics below, can help us identify the prevailing phase of the cycle for a given country or sector.
Measuring Market Fragility
We recognize that macroeconomic data can be significantly lagged and error-prone (subject to revision). Often, by the time the data identifies a downturn, markets have already repriced. If MAC strategies do not have a forward-looking perspective, they run the risk of unnecessary exposure to rising market stress or market crashes.
UNDERSTANDING DEGREES OF MARKET STRESS AND THEIR IMPLICATIONS
Using our proprietary Crisis Sensitivity Ratio (CSR) that attempts to highlight increasing probabilities of a crisis, we monitor market fragility across global asset classes to better understand what is driving valuations; the insights we gain contribute to decision-making and positioning.
The left-hand chart below depicts a historical snapshot of the stock market. During high-growth periods, such as mid-2006, stocks tend to exhibit low interconnectedness to each other. Conversely, in stressed regimes, stocks tend to become highly correlated (right-hand chart). When our interconnectedness measure increases, we anticipate increased levels of market volatility.
We apply this same quantitative approach to assessing the fragility of global credit markets. When degrees of market stress shift, we use these signals as inputs to guide our tactical portfolio allocations.
Our MAC strategy draws from a global opportunity set that spans investment grade, high yield, bank loans, securitized and emerging market issues. Risk premia associated with these sectors are constantly shifting. Therefore, a robust approach to allocating to what we see as the most attractive sectors is an essential source of alpha potential. “According to well-known studies by Brinson and Colleagues, more than 90 percent of the variability in a typical plan sponsor’s performance over time is the result of asset allocations policy.”i
The following table shows how different sectors behave in different phases of the credit cycle, a critical component of cross-asset risk premia. Forward-looking analysis of credit cycle regimes, combined with our analysis of market fragility, underpins our approach to harvesting credit risk premia.
Ultimately, our quantitative research informs a qualitative judgmental approach to asset allocation, based on the collective experience of an established three-person portfolio management team.
We believe MAC should be considered a comprehensive solution for fixed income investing. Through a deep understanding of the credit cycle, we aim to tactically re-weight fixed income assets with the goal of achieving the highest risk-adjusted return potential during each phase. By adjusting exposure to higher- or lower-quality securities, a MAC strategy can also dynamically shift the intrinsic beta of those investible assets, depending on the degree of market stress.
Once top-down asset allocation targets have been determined, special attention is given to security selection through bottom-up, fundamental credit research. We believe investing in companies and countries that are able to meet their repayment obligations, thereby minimizing the risk of suffering rating downgrades or defaults, is critical to potential success. In order to facilitate this, we utilize our credit research department with over 50 full-time credit research professionals. This group provides real-time, forward-looking information on the creditworthiness of the companies and countries they cover, both on an absolute basis and relative to other, similar companies/countries.
Holistically, the strategy’s tactical nature, combined with its inherent diversification, helps enhance the portfolio’s Sharpe ratio by mitigating exposure to large drawdowns during volatile markets. We believe over a full cycle, MAC strategies have the potential to achieve high yield-like returns with lower volatility, likely offering a viable substitute for those looking to diversify away from more constrained, single-asset credit portfolios, or higher-risk equity strategies for those that are on a de-risking path.
iDoes Asset Allocation Policy Explain 40, 90 or 100 Percent of Performance?, Roger G. Ibbotson and Paul D. Kaplan, Financial Analyst Journal, January/February 2000.
iiRegime periods as shown on page three are determined by the investment team based on a variety of subjective and objective factors, including past economic and asset performance metrics. Views and opinions expressed reflect the current opinions of the investment team, and views are subject to change at any time without notice. Other industry analysts and investment personnel may have different views and opinions.
This material is provided for informational purposes only and should not be construed as investment advice. Any opinions or forecasts contained herein reflect the subjective judgments and assumptions of the authors only, and do not necessarily reflect the views of Loomis, Sayles & Company, L.P. Investment recommendations may be inconsistent with these opinions. There is no assurance that developments will transpire as forecasted and actual results will be different. This information is subject to change at any time without notice.
Charts are illustrative for presentation purposes only as a sampling of risk management tool output. Market scenarios have inherent limitations and should not be viewed as predictions of future events. They rely on opinions, assumptions and mathematical models which can turn out to be incomplete or inaccurate.
Commodity, interest and derivative trading involves substantial risk of loss. This is not an offer of, or a solicitation of an offer for, any investment strategy or product. Any investment that has the possibility for profits also has the possibility of losses.
Past performance is no guarantee of, and not necessarily indicative of, future results.
LS Loomis | Sayles is a trademark of Loomis, Sayles & Company, L.P. registered in the US Patent and Trademark Office.