Be selective with your fixed income in this late cycle phase

From

Bob Sahota

“Investors repositioning risk for a correction due to this late cycle economic environment are turning to less riskier assets like fixed income, however what we see time and again of concern is an over exposure to assets that have higher correlation with equity markets and no protections.

This significantly increases the sequence of return risk that can undermine a seemingly well constructed portfolio.” according to Revolution Asset Management’s CIO and veteran investment manager, Bob Sahota.

Like many alternative investment strategies that have been designed to produce consistent income for investors fixated on yield, private debt (or direct lending) exhibits low correlations to major asset classes. Private debt involves the sourcing and managing of loan portfolios that help to fill the current financing gap created by the long term decline in lending by Australian banks to Australian businesses. It affords investors a number of structural protections through seniority, security and covenants, which combine to mitigate the risk of the investment and likely improve recoveries should the borrower face distress.

“We often get asked where should investors be positioned in this late-cycle phase, quite simply you want to be converting from unsecured to secured assets – from being overweight in unsecured bonds (such as global and domestic high yield and investment grade bonds) where you don’t have security, covenants and protection from cash flow leakage and M&A risk.

We believe it’s a good time to reallocate defensive investment holdings to where you gain access to the benefits of security whilst also receiving a regular income. A key attribute of Australian private debt is that it provides access to contracted income of 4% to 5% over the cash rate through the investment period, for each investment. Should there be a down turn or a major correction in markets given this late expansionary phase, you want to be at the senior secured end of the capital structure.” said Mr Sahota.

As private debt is typically senior with debt holder interests ranking before other creditors, this entitles debt holders to priority payment.  When compared to domestic and offshore high yield, corporate credit and US Leveraged loans and CLOs, Australian private debt offers the most complete package in terms of protection in this late cycle phase.

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