As regular readers are aware we favour investment grade bonds which we deem are ‘undervalued’; thus providing attractive risk-adjusted expected returns and sufficient credit notch cushion; against any unforeseen events. We also tend to favour quasi-sovereign holdings, which are broadly state-owned, thus strategically important to the government, and trade on spreads much wider than the sovereign curve. To this effect our current exposure to sovereign and quasi-sovereign across our portfolios stands at ~80% and above.
There are however a number of corporate issues we favour; here the quality of credit and spread cushion are crucial. One example could be a holding in AAA rated Microsoft 4.2% 2035 which is currently trading at a spread over 115bps over US Treasuries (“UST”); similar AAA bonds trade at only ~45bps over. Currently offering an attractive expected return and yield at ~13%, with 5.5 notches of credit cushion, we calculate the bond's expected capital gain, were it to reach fair value, at over 10 points.
There have been a number of interesting corporate issues out this week, some of which have looked relatively attractive, while others have not offered enough in terms of spread cushion. Today’s offering from Kuwait Projects (KIPCO) is a perfect example. Rated BBB- (one notch above junk) the 10-year issue, is currently being offered at a yield of 4.75%; which would be a welcome holding in most portfolios. However, using our proprietary Relative Value Model, we calculate the expected return stands at a mere 2.6%; as it trades only 32bps wider than similar securities. Although we have been long term holders of the major investment holding company in the past, and the Kuwaiti ruling family indirectly owned a large stake in the company, this issue offers very little in terms of cushion, with less than one notch of credit protection.
Ahli Bank Qatar, another corporate new issue to the market priced today at +163bps over UST, which is relatively attractive given similarly rated A2 bonds with a duration around 4.5 years trade at ~91bps. The expected return and yield is calculated at 6.6%, with 3.3 notches protection. Although this bond offers far more spread cushion than the KIPCO issue and a higher credit rating, we would not look to hold it as we have chosen to not hold GCC banks at the moment, and Ahli Bank is tiny (~3% market share in terms of assets), with little to no guaranteed government support.
We look to maintain our portfolios’ credit quality at a weighted average single A rating, and continue to search for value opportunities. We avoid taking any unnecessary risks when building our portfolios by: undertaking sufficient credit analysis and evading the ‘search for yield’ trap.