Credit risk rating spotlights new opportunities for investors
Andrew Cleeland
A credit default model that improves on conventional credit ratings, involves deep analysis of key financial ratios and gives as much weight to predicting negative events as positive ones, is delivering consistent positive returns for specialist investment manager, Omega Global Investors.
The process represents a refinement of the existing Omega Financial Health Rating™, enabling Omega to effectively compare credit risk both within and – significantly – between sectors. It also enables effective comparison irrespective of geography, so developed and emerging market companies can be compared like for like.
To date, Omega’s process has proved more accurate in identifying mispriced credit than that of major ratings agencies.
“Mispricing spells opportunity for investors but is not always easy to spot except in hindsight,” explained Omega Investment Research Analyst, Andrew Cleeland, who has played a key role in developing and refining the Omega health rating.
“This is generally because of the complexities of comparing different issuers from different sectors from different regions – in other words, factors that that can change from moment to moment. Our model has been designed to capture this complexity, giving us a ‘top down’ approach that highlights where the opportunities are.
“We also benefit from the fact that the Omega credit default model is fast moving, while credit ratings are often tied up in red tape which slows their process down. We are able to cut through that tape so to speak.”
Mr Cleeland went on to cite examples. In companies from the same sector – transport – for example, he pointed to Qantas and Kansas City Southern.
“Both are rated BBB by S&P, however our health rating give different results. While our health rating for Qantas is equivalent to the S&P rating largely due to higher than average leverage and poor recent earnings results, we rate Kansas City Southern better – largely due to its lower leverage and stronger cashflow.”
When it comes to cross sector comparisons, Mr Cleeland compared Kansas City Southern with consumer staples companies ConAgra Foods and Avon – both of which are also rated BBB by S&P.
“We would in fact rate ConAgra Foods somewhat higher and more on par with Kansas City Southern due factors such as its low leverage, strong cashflow and stable dividends,” he said.
“These two companies can be validly compared not only because they have strong financials for their respective sectors, but because their sectors also have similar low historic rates of default – also factors that are incorporated into our final rating.”
“Our process has been refined and developed over time to encompass a growing number of financial ratios including profit, leverage, market information and efficiency,” said Mr Cleeland.
“The fact is that in a market environment that’s characterised by shift and change – more often than not defying convention – it’s up to investment managers to be aware responsive to the conditions environment rather than using backward-looking tools to make forward-looking decisions. And it’s the investors with the best tools who will be best positioned to gain.”
