The 27.79% return of Hermes Multi Strategy Credit since its June 2013 inception has been driven by implementing our global, unconstrained approach1. The Strategy, which has grown to over $1bn in AUM, aims to generate strong gains from our best credit ideas while minimising downside risk through a dedicated exposure to defensive strategies. Importantly, the portfolio experienced far less volatility than the global high-yield market amid market and macroeconomic shocks, producing a Sharpe Ratio of 1.83.
Figure 1. Hermes Multi Strategy Credit v the global high-yield market
Source: Hermes. Performance shown is gross of fees and on a cumulative basis for the four-year period ending 31 May 2017. Past performance is not a reliable indicator of future performance.
Hitting the mark: The aim of Hermes Multi Strategy Credit is to use the full breadth of the global liquid credit asset class, investing in bonds, derivatives and loans to deliver high-yield-like returns with lower volatility throughout market cycles. Seeking this outcome, we combine high-conviction investments with defensive trades by searching throughout the capital structures of issuers worldwide to identify which bonds, derivatives and loans offer superior return prospects or can be used to effectively mitigate risk. Since the launch of the Strategy, we have invested through the taper tantrum, China slowdown, global high-yield sell-offs and the recent turbulence in oil prices, the vote for Brexit and election of Donald Trump. Significant periods for the Strategy include:
2017 – calm between storms: for credit investors, the year to date has largely been characterised by rallying markets. In this benign environment, we aim to optimise the convexity of our credit exposure to maximise upside capture. We have also sought to increase returns by taking positions further along the credit curve and by finding attractive opportunities in unloved sectors, such as US retail. This has helped us generate a 3.69% gross return2 in the five months ending 31 May 2017.
2016 – fundamental focus: Through intensive bottom-up research, we have executed contrarian trades such as our investments in the global mining sector in early 2016, which was still experiencing a cyclical downturn. Anticipating creditor-friendly moves by stronger companies to bolster their balance sheets by cutting dividends, reducing capital expenditure and selling assets, we increased our exposure to the sector from 12.8% to 19.1% between Q3 2015 and Q1 2016. Among the issuers we invested in were Vale and BHP, which benefited from strong asset quality and conservative financial policies. Throughout 2016, our exposure to mining companies contributed strongly to our overall return, showing the benefit of favouring fundamentals instead of prevailing sentiment.
2015 – avoiding the lows of high yield: In Q4 2015, amid growing certainty that the Fed would raise rates for the first time in almost a decade, liquidity fears spurred a global high-yield sell off that drove the market -0.66% lower for the quarter. It ultimately returned -2.03% by the end of the year. In the preceding months, we increased our investment-grade credit and leveraged-loan allocation to 30% of the portfolio, and this exposure to higher quality assets preserved capital during a period of market stress and helped drive our 1.05% return for 20153.
Figure 2. Smooth delivery: portfolio exhibits less volatility than the high-yield market
Source: Hermes as at 6 June 2017
2014 – Tapping the good oil: In October 2014, oil prices began to fall precipitously after OPEC refused to halt production despite global oversupply. This adverse impact on the US shale market, where many producers were highly leveraged due to higher operational costs, would soon be felt in the high-yield market. Two months before oil prices began to slide, we cautioned that investors should be particularly selective in the North America shale oil and gas market as it featured many entrants with uncertain long-term prospects. We avoided these stressed companies and exploited the breadth of our universe by investing in more mature commodity businesses with proven operations and reserves, and in undervalued but robust oil companies in the politically beleaguered Russian market.
2013 – the taper test: In Q2 2013, when the Federal Reserve first indicated that it would reduce quantitative easing after almost five years of running the bond-buying programme, the market’s acute sensitivity to changes in US interest rates became clear. Fear of a rate hike had already caused overcrowding in short-duration bonds, and this strong demand allowed issuers to introduce looser covenants and shorter non-call periods. We were unwilling to accept the consequent risks – high valuations, weaker investor protections and diminished upside – and invested in credit default swaps of companies instead to gain a similar short-duration exposure. We avoided two-thirds of the drawdown, returning -0.95% compared to the market’s -2.76% for the month of June4.
Maintaining momentum: Our flexible investment approach has driven the strong risk-adjusted returns of Hermes Multi Strategy Credit in its first four years, as evidenced by its Sharpe ratio of 1.83 for the period, despite macroeconomic and technical market shocks5. Amid the current risks – from geopolitical developments, the pace and extent of US monetary-policy tightening and China’s mounting corporate debt – we continue to find opportunities to generate attractive returns and preserve capital.
- 1 Source: Hermes as at 6 June 2017. Performance shown is gross of fees and on a cumulative basis for the four-year period ending 31 May 2017.
- 2 Performance shown is gross of fees for the 5 months to 31 May 2017.
- 3 Performance shown is gross of fees for the 12 months to 31 December 2015.
- 4 Performance shown is of the Bank of America Merrill Lynch Global High Yield Index as at June 2013.
- 5 Source: Hermes as at May 2017. Annualised Sharpe Ratio calculated on a gross basis for the four-year period ending 31 May 2017.
Addressing risk management from a macro perspective