Is your fund manager exercising bond sense?

Bond managers specialize in tough questions – go ahead and ask

In discussions with clients this year, so often we have come across questions about timing. Is it time to move from GICs to bonds? Is it time to jump into high yield? Is it time to allocate to or away from investment grade? When is the bottom?

If they do indeed find the correct answer, the clients in question may be able to turn a quick profit from a timely trade in their book. But regularly repeating such fortuitous rebalances is difficult. Putting ourselves in the chair of a client interviewing a prospective manager, we might not spend so much effort on seeking opinions on these difficult-to-know and hard-to-execute subjects. Instead, we might try a different tack: “Is the manager approaching the market sensibly?”

Now, how one determines whether a credit manager is doing their work sensibly is more of an art than a science, but we would point to the following lines of questioning.

Are you managing for value or are you managing for coupon?

Sometimes fat coupons make a lot of sense if they are accompanied by an underlying business valuation that well supports the credit stack of an issuer. But on other occasions, smaller coupons can make sense if they offer better capital security or, in the case of a convertible bond, some realistic potential for equity-based appreciation. And sometimes a defaulted security, offering no coupon whatsoever but cleansed of excess debt in the wake of a restructuring, may turn out to offer the most value of all. The key, in our view, is to manage for value.

Do you test the issuers in which you are investing to see if they are robust enough to withstand a typical recession?

It is difficult to know whether a recession is or is not going to happen at a given time. However, it is much less difficult to form an opinion of whether a particular issuer, given its business profile and debt burden, is likely to sail through a typical recession without credit troubles. Has the business demonstrated robust profitability in past recessions? Is the company’s debt burden small enough that interest can be paid easily upon a contraction of profit margins to historic lows? To us, it is more important that a portfolio be comprised of issuers that can withstand recessions than it is to know, in a precise sense, when a recession might arrive.

How do you plan for providing client liquidity at inconvenient moments?

Every manager is happy to crow over successful trades in cheap but illiquid securities. But in our view, managing a credit mandate well necessitates both a strong understanding of the liquidity of various parts of a portfolio and the humility to imagine a scenario in which a sizeable proportion of one’s clients want their money back.

In our case, we stress-test a one day, 50% redemption. Thanks to the kind countenance of fate, we have not, thus far, been called on to provide such a flood of liquidity. But we heed Benjamin Franklin’s warning, “By failing to prepare, you are preparing to fail.” And so, the stress test is our guide.

When it comes to credit mandates, as with shoes, we know “sensible” is not sexy. But in this year of turbulence and extremes in sentiment, we think managing sensibly is what is needed.

Geoff Castle is Portfolio Manager of the Pender Corporate Bond Fund at PenderFund Capital Management. Excerpted from the Pender Fixed Income – Manager’s Commentary – July 2022. Used with permission.

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