The boxes that investors should be ticking in this asset class

Korber: Government bonds and corporate bonds are quite different beasts. 

Government bonds are really about interest rates and committing to a fixed interest rate for a long period of time. So they're relatively one-dimensional - it's about interest rates. 

The world of credit, the world of corporate bonds is much more diverse. So we've got a universe that is both fixed rate and floating rate. So the interest rate risk that you take is much more diverse than you have with government bonds. The types of issuers we have are much more diverse. We have large corporates, we have private debt, we have securitised assets, and they each have a different risk and return characteristic. 

In general, government bonds are fairly one-dimensional. They are a very good risk metric in a credit sense but are very limited in all of the other metrics. The wall of credit has a lot more diversification, and from our perspective as managers in that space, a lot more opportunity to add value to our investors.

Korber: The world of credit is really about lending to a universe outside of government. That includes investment-grade credit. They're all of the common garden variety, large corporates that we know. It could be a Woolworths (ASX: WOW), it could be Macquarie Group (ASX: MQG), or it could be an IAG (ASX: IAG). 

The world of investment grade credit is low default risk and a reasonable but moderate coupon. So very dependable, very predictable. 

The next tier is outside of that investment-grade universe and goes into the world of high-yield opportunities. These could be smaller corporations issuing bonds or moving into the world of private debt. We're looking at borrowers who are looking to the capital markets to borrow money as an alternative to the banking sector. That is a very broad space. It can be anything from very large corporates to your local corner property developer. 

The last leg in the credit world, which is pretty relevant and productive in Australia is securitised assets. So your housing loan, your car loan, etc, can be resold by your financial institution and form an investment in a portfolio run by a credit manager.

How do you define “fair value” in the credit markets?

Korber: In credit markets, we're being paid a yield or a credit spread to compensate us for investing in a particular security. 

The things we look for to price that correctly are firstly, the credit quality of the issuer. So if it's a very high-quality issuer, obviously that credit margin can be lower, whereas a very risky issuer, you need a much higher level of yield to compensate you for that. 

The second one is the term, so how long are you being asked to invest for? The longer the term, typically you're going to ask for a higher price to make that investment. 

And the third factor is liquidity. So if you are investing in a security that you can easily trade subsequently, you'll be willing to take a lower margin than say private debt where you're locked in for five or six or seven years, or whatever the term of that private debt is. 

We try to look at each of those factors and amalgamate them together, and that generates what we think is a fair return for that asset. And then we look at where that asset is being priced in the market. And if we can buy that asset more cheaply than our fair value, it's an attractive investment for us.

Korber: We try to make sure that we research our investments thoroughly. We want to understand what is driving the risk within that investment, and the risk is multi-factoral. So it is the credit quality of that issuer and it's the quality of the documentation that you're relying upon. It is the position that the issuer has within their market and it's the level of pricing power that they've had in an inflationary environment, which is pretty important in the current world. 

So it's step-by-step, assessing each of the risks that they're exposed to and making sure that you put a tick on each of those boxes. And if you've got conviction around the creditworthiness of that issuer, you then look at the price you're being offered because I think the yield is never sufficient to compensate for lending to a poor issuer. 

So one example of an issuer that we like that ticks all those boxes is the vehicle that owns Arnott's. So Arnott's Biscuits has a fantastic market position, and they have great management. The legal structure around that particular loan was very investor-friendly. And so all of those things came together to make, in our view that particular investment attractive to us. And that's been in the portfolio for a couple of years now, and every year, it ticks along with really good returns for us.

Learn more

The Perpetual Credit Income Trust (ASX: PCI) aims to generate sustainable, regular income by investing in a diversified portfolio of credit and fixed income assets. For further information, please visit their website, or the fund profile below. 

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Perpetual Credit Income Trust (PCI)

Australian Fixed Income

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