Departure from Trump, Brexit effect buoys global credit opportunities

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Australian investors are typically under-exposed to global fixed-income markets--both developed emerging--where political shifts and fiscal volatility are creating attractive buying opportunities.

Direct investors are yet to turn their attention to global fixed income to any great degree, and for various reasons, including high cash rates and structural challenges in accessing products.

While Australian institutional investors have had sizeable fixed-income exposure for decades, in the direct investment space, "it's not a conversation that's happening yet. SMSFs tend to be in cash, local equity, and property," says Andy Sowerby, country head, Legg Mason Australia.

"That part of the market looking towards fixed income is still very early in that conversation--partly because of the difficulty of buying securities direct ... it's structurally difficult for SMSFs to buy fixed income as a direct investment, as they do equities and property".

Sowerby expects there to be various fund managers increasing their product set in this area, including Legg Mason, which is considering fixed-income ETFs: "We think that will be an area that will continue to grow, and we are looking at that also, to help serve that part of the market."

Legg Mason is a multi-affiliate asset management business, with Legg Mason Brandywine Global Opportunities Fixed Income [16192]--which has a Morningstar Silver rating--among its product line-up.

Visiting from the US, Gary Herbert, Brandywine's global credit portfolio manager, says the skittishness of markets in recent months has created excellent buying opportunities.

"The markets over the past several months have been really nervous about what was happening in France, and that allowed us to buy both corporate credit and emerging markets while people were extrapolating what happened in the UK and the US and applying it to continental Europe," he says.

The same dynamics were exhibited in relation to emerging markets, which "to us, based on the fears of the shutdown of  TPP [Trans-Pacific Partnership], and the concept of the renegotiation of NAFTA [North American Free Trade Agreement], created a lot of price volatility".

"When you see valuations at these extremes, that's something that we view as a buying opportunity. And ultimately, in many of these emerging markets, they're actually making more structural changes than in developed markets ... they're taking measures we're not willing to take [in developed markets]," Herbert says.

Understand politics to know emerging markets

He believes a well-developed understanding of political outcomes is an intrinsic part of being successful in investing in emerging markets: "The key part about understanding emerging markets has been understanding political volatility."

The spill-over of political volatility into developed markets, with such uncertainty traditionally only seen in emerging markets, is something quite new.

"Brexit and the Trump administration caught many off guard, but that's something that we've been incorporating into our decision-making processes. It's not something that's always captured by a valuation model, but a soft factor that has to be discussed and evaluated," Herbert says.

"Without getting too technical, that's something that can be picked up in options markets, or probability distributions. We try and look at different markets, whether its options, currency, credit, or even equity markets, to make those determinations, and that's been part of our approach."

Beyond less-developed markets, he believes Australian investors may also find good opportunities in the US high-yield fixed-income markets: "Admittedly, valuations are on the tighter end, they're not as statistically cheap as we would like ... but they offer significant value."

In terms of monetary policy, "we see a benign outlook" and Herbert also expects a continuing fall in default risk, to sub-2 per cent over the next six to 18 months.

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Glenn Freeman is a Morningstar senior editor.

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