In an era of unknowns, idiosyncratic opportunities abound…
If the last two years have taught investors anything, it’s just how sensitive most asset classes are to interest rate changes. In navigating a myriad of unknown variables, accurately predicting the macro landscape has proven challenging in recent years. Therefore, we believe the current environment presents an excellent opportunity to invest in alternative strategies that focus on generating alpha.
Picton Mahoney’s (PMAM) fixed income team has identified these seven alpha themes for 2024 that they believe can make a positive difference.
1. Mergers & Acquisitions (M&As) and event-driven credit investing
This type of strategy generally aims to identify and capitalize on credit issuers undergoing significant changes such as M&As, spinoffs or capital allocation shifts.
PMAM’s view
With inflation stabilizing and interest rate cuts on the horizon, our team is now seeing a resurgence in M&A deals, creating potential for uncorrelated double-digit returns in these event-driven credit refinancing situations.
2.Hybrid debt of investment grade (IG) issuers
Usually issued by pipeline and utility companies to fund specific projects, hybrid debt is a part of the capital structure that is below senior debt, but above common equity.
PMAM’s view
While credit spreads at the index level look expensive, this particular segment of the credit market continues to trade at close to historically wide spreads. We are now seeing an appealing risk/reward dynamic in some high-quality issuers offering yields exceeding 8%.
3.Yield-to-view (YTV) in discounted bonds
These are low dollar-price bonds where we believe the issuer will refinance or redeem them prior to maturity (for example a company might opt for refinancing when the bond first becomes callable at par as opposed to later).
PMAM’s view
We believe that having a view on a bond’s call date can have a dramatic impact on the potential yield, i.e. YTV. By pinpointing this opportunity through analysis and engagement, we aim to capitalize on these kinds of mispriced opportunities.
4.High reset preferred shares
Rate-reset preferred shares are issued at a fixed spread to a benchmark like the Government of Canada five-year rate. After five years, the coupon resets to the new prevailing five-year rate unless it is redeemed by the issuer.
PMAM’s view
While we typically don’t participate in the preferred share market due to its inherent volatility, we do allocate tactically when compelling opportunities arise. Last year’s volatility in the preferred share market gave rise to an opportunity to invest in higher reset preferred shares that were trading at a significant discount.
5.Canadian bank capital securities
This opportunity includes additional Tier 1 bonds (AT1s), Limited Recourse Capital Notes (LRCNs), and Credit Risk Transfer securities (CRTs) with asymmetrical risk/reward potential.
PMAM’s view
As regulators boost work to strengthen the banking system through rising capital requirements, major banks have responded with creative strategies including a boost in issuance of these unconventional capital securities. Our team has been strategically investing in this trend.
6.Short-side alpha in deteriorating credits
With the easy money era now behind us, poor performing and over-levered companies will likely struggle to refinance their existing bonds at maturity.
PMAM’s view
Shorting these bonds can serve as a portfolio hedge against our long positions and also presents a potential source of alpha. Unlike traditional long-only managers, our team is able to capitalize on deteriorating credits by strategically leveraging the short side for alpha generation.
7.Macro rate and credit hedging
Using derivatives to hedge rate and credit risks has been a critical tool to help our investors navigate volatile market environments.
PMAM’s view
With credit spreads hovering near historical lows, we see an incredible opportunity to hedge and potentially profit from widening spreads in 2024.
