Just because interest rates are being cut right now doesn't mean investors should take more risk

Note: This episode was taped on Wednesday 2 October 2024.

The first Federal Reserve interest rate cut for four years sparked a rally in many asset classes and encouraged some investors who had been sitting on the sidelines to take on some more risk. But don't count Tribeca Investment Partners' John Stover in that bunch. While he says the first rate cut will be a tailwind for his portfolio, it's not an instant cue to start taking more risk.

"I think we're going to stay balanced between investment-grade and high-yield [credit]," Stover says. 

"First, we benefit from our portfolio on the investment grade side but while we may add more high yield over the next six to 12 months, the target going forward is likely to still remain balanced because we remain a little concerned over the risk of a US recession."

Stover invests in a lot of areas that others won't touch - like the high-yield debt of Indian renewable companies or investments in Macau's casino companies. In fact, his portfolio often reflects positions in entire economies that don't even get a look from other investment managers like Indonesia. 

It's a process that's paid off - returning 15%+ a year over the last two years - and is likely to return at least that much moving forward.

In this episode of The Pitch, Stover joins me to examine this eclectic asset class and the opportunities that exist in it today. 

EDITED TRANSCRIPT

LW: Fixed income is supposed to be an asset class for generating yield. Which corporates or sectors are you finding your most yield in at the moment?

Stover: If you look at what we do, we're about 50/50 investment grade and high yield on the investment grade side. We really like the BBB space. I think the higher-rated A/AA/AAA space has gotten a little bit tight, but BBBs are still close to the highest yield that you've seen over the past 10 to 15 years. Particularly when you think that we're at the cusp of the rate-cutting cycle, you're going to get a big benefit from that as those rate cuts come through. 

To be honest, around the region, it's hard to pick out one particular sector or country, but we've had financials, energy names, and industrials in the BBB space across Southeast Asia, India, Australia, and even a little bit in China and Hong Kong. 

On the high-yield side, there's still a lot of good value across both BBs and single Bs. The sectors that I would call out that we like the best are - Indian renewables where we're still finding really good value, relative to not just the green bonds that you would find elsewhere in the world, but just BBs as a whole. We're still finding good value there at 7-9% yield and these are stable businesses. 

We quite like Macau gaming at the moment and we've increased exposure there. This has been one of the sectors that has been a bright spot in China's COVID reopening where a lot of other sectors have disappointed. You've seen mass gross gaming revenue higher than pre-COVID levels and the valuations of the market just really haven't reflected that. We do think that's going to get a big boost from the China consumer stimulus that you're seeing unveil at the moment. 

Indonesia is another one that we like as well. We're finding value across the property space and natural resources there. That's been an overlooked market for a lot of people, not just globally, but even in the region. It's kind of been a stay away from them.

LW: Why has it been a stay-away for investors?

Stover: There were some negative credit issues in the 1990s and 2000s and I think a lot of people just stay away if they don't know which companies to get involved with. But I've been investing in the region for 14 years, both directly lending to companies there as well as investing in liquid tradable bonds. 

I know which companies, which families and business groups to get involved with and which not to. And we've had really strong returns from Indonesia over the past several years. 

LW: How do you mitigate risk in the Asian credit universe?

Stover: We really focus on risk management and downside protection, not only as we think about which longs to put in our portfolio, but also through hedging. We are a long-short fund and while we're long biassed, we have a portfolio of shorts that we use to both express negative views on the companies and to also hedge the portfolio. 

On the hedging side, we look to have CDS (credit default swaps) where we're buying protection against defaults. Then, we also have a portfolio of tail risk hedging as well. Those all contribute to reducing the volatility in the portfolio. 

And if you look over the past two years, we've produced over 15% net returns in the portfolio with very low volatility. If you look at an experience like what we saw in August this year for instance, where Japanese, Taiwanese, and Korean equity markets were each down the most in 30/40/50 years in one day. We were never down more than 0.7% month to date in August. And the same was true for the volatility in September. So I think that shows you how well the portfolio can hold up in times of really high stress in global markets. 

LW: Does the first rate cut cause you to add more risk to your portfolio?

Stover: I think we're going to still stay balanced between investment grade and high yield. Rate cuts tend to benefit the investment grade market the most. Those are the most sensitive to interest rates on the bond trading side. Now, of course, if you look at corporate cash flows and earnings trajectory, your high yield is going to be more sensitive to that. 

First, we benefit from the investment grade side of our portfolio. We may look to get more high yield over the next six to 12 months, but I think the target going forward is likely to be still balanced around investment grade and high yield. 

We are still a little bit concerned about the US and recession risk next year. While I think Asia is much better set up this time to withstand those impacts, because most of what we're exposed to has good domestic demand stories like Indonesia and India, it's not as exposed to what's happening in the US as some of the export economies like Korea and Taiwan where we don't have much exposure. We are still a little bit cautious if we do see a US recession next year. 

LW: What kinds of returns have you been generating with this process?

Stover: We've done over 15% net for the past two financial years in Australia and that's been a combination of both income and capital appreciation. There are both of those components in our strategy. We've distributed between 6-7% annually in the portfolio. And then obviously there's been another component of capital appreciation as well. So you've seen roughly a 50/50 split since inception between capital appreciation and income. We expect that to be roughly the same going forward. 

Learn more

The Tribeca Asia Credit strategy uses a long short approach to extract high-quality returns from the Asia Pacific corporate bond market. For further information, please visit their website.