This dark horse boutique snatched the titles Manager of the Year and House Award in two of the most competitive categories, High Yield Fixed Income and House Award for RMB Fixed Income respectively. BENCHMARK explores how this 23-year low profile investment house, Income Partners, quietly adds value to its shareholders.
BENCHMARK: The firm has a unique approach when it comes to viewing risks and returns. How did you get out on top in limiting your downside losses and gaining upside potentials?
Raymond Gui: Yes, we firmly believe that managing downside loss is as important as managing for upside potential. We pin our investment objectives on three main components – conducting fundamental credit research and investing only in businesses we understand; avoiding large drawdowns via top-down macro analysis, systemic and portfolio risk management; and adhering to the tried and tested investment processes, tools and discipline we have used since 1993. It is important to note that the robustness of all three components is driven by one factor, human capital. We believe systems, tools, and research are not unique; what is unique is the people who interpret this information and make investment decisions. Investment is not a science, it is an art; we believe having the most experienced Asian credit investment team helps differentiate us from our peers.
BM: Can you explain how your credit selection process work especially where China is still behind on its transparencies and fairness to minority shareholders?
RG: Our due diligence includes a bottom-up credit selection process, analysis and monitoring of each of the individual credit investments by stress-testing them under different scenarios and looking into their fundamentals. We gather general market intelligence, sell-side research, and publicly available information, but the final investment decision is made based on our proprietary research models. We actively engage the companies’ management to gain first-hand insight to reduce “information integrity risk”. We have analyzed hundreds of regional credits over the years and have met every high yield bond issuer. Our internal rating system is especially crucial due to the lack of international ratings for many onshore Chinese credits that do not issue in US dollar. This process ensures that we are better informed of the underlying credit risks, fair pricing and relative values of the unrated credits when making investment decisions in the onshore CNY bond market.
Our first rule is to preserve capital because we are a boutique firm that survives purely on our investment capability. Is our credit research or technical analysis better than other firms? We do not know. What we do know is that our investment team anticipates risk and volatility well and avoids taking unnecessary risks for our clients. After all, this is a fiduciary business, and our duty is to protect our clients’ assets at all times.
BM: When it comes to putting your portfolio together, what is the criteria for inclusion? What are the ceilings for one single issue and how diversified is your High Yield portfolio right now?
RG: Our portfolios are constructed based on the investment committee’s overall macro view, i.e. risk on, risk off or trading range environment, and no outsized bets on any one individual credit are ensured. Our actively managed top-down research process helps determine sector exposures by considering macroeconomic conditions, industry dynamics and policy directions in each market.
Our High Yield portfolio is highly diversified: we have over 60 holdings, with each holding contributing less than 2% of total portfolio composition unless it is a conviction name which we can have up to 3%. Portfolio managers, who follow their respective portfolio investment guidelines, actively manage risks on sectors, duration and liquidity according to the overall macro view to outperform in up markets and more importantly, capture less in down markets.
BM: You have many examples to showcase your successful strategies, and one of which was West China Cement. Can you tell us how ideas were generated on entries and exits of these holdings?
RG: Sure. Our investments are separated into two types of different allocations and trading strategies. Buy-and-hold “fundamental” investments that serve as core return generators, and trading-oriented “tactical” investments as additional return generators. The allocation of our core and trading portions of the portfolios is determined based on our top-down views.
As to our success showcase, West China Cement, the company is B+ rated and a leading Chinese cement producer that we have been following since 2011. We began to underweight China’s cement sector in early 2014 due to the slowdown of China’s property and infrastructure investment and oversupply issue within the industry. In January 2015, we realized that the price war in Shanxi province had ended, and the cement price was beginning to stabilize. In combination with the monetary easing in China since November 2014, we bought the bond in two tranches at 95.25 and 94.75. The bond tightened in March 2015, and we subsequently took profit in May 2015 at 100.625 as the yield became tight compared to other B+ rated credits.
Leveling with risks
BM: You’ve managed to outperform your peers while maintaining a below category average risk profile. What does your risk control model look?
RG: We have successfully beaten the market during major economic downturns in the last two decades, thanks to our disciplined approach to our portfolio monitoring and risk management process. This discipline is an integral part of our investment process, which is structured to identify, manage and mitigate risk at three broad levels. Firstly, the firm-wide business operational & compliance risk; secondly, our macro and top-down strategy risks from observing general market trends and credit, interest rate and currency risk; and finally, portfolio risk, which refers to our overall portfolio construction risk, underlying credit-specific risk and risk monitoring.
BM: RMB is a volatile currency not to mention its current market condition. How do you protect your shareholders from currency risk?
RG: Risk and overall exposures in our offshore RMB portfolios are actively scaled based on market conditions. We view stable carry, i.e. coupons, received as a core return driver. We actively use hedging strategies to manage cash, rates, and duration exposures. Also, our rates overlay strategy guides our currency views on Asian rates in both steepening and flattening directions.
BM: How do you monitor your positions and what are the measures taken when an issue is downgraded during the process?
RG: To help monitor our portfolios against strict investment guidelines, real-time risk management tools are deployed to help our portfolio managers understand the risks and attribution of their portfolios in real time, such that they can react and rebalance the portfolios as required. Our trades are automated, and positions are entered electronically and updated on a real-time basis. We have systems that adequately track the portfolios’ risks and return drivers. We increase or decrease our positions to ensure that the overall risk level adheres to the investment objectives and more importantly, our current views on the market.
Looking into the future
BM: How shall we read the situation happening in China at this moment? Do you see continued China’s slowdown becoming a negative impact on credit, and which sectors are still attractive?
RG: China is transitioning from an investment-driven economy to a consumption-driven economy. It’s a challenging operating environment for weaker credits, especially ones from investment-related sectors. Despite the overall bearish sentiment towards China’s slowdown, we can still find good value in high-quality credits from certain sectors, such as the consumer and utilities sectors. In the Asian high yield space, we believe that BB+ rated credits is the ‘sweet spot’ because of the low default risk and wide valuation.
BM: What is your current exposure in investment-grade credit, over sovereign and high yields, and what is the average duration? Do you see more risks in the High Yield space going forward?
RG: Considering the increased volatility in global markets, we believe that it’s time to be defensive in high yield credits. We favor investment grade and high-quality high yield, which is selected above BB- rated credits because of their attractive valuation. Currently, our high yield strategy has about a 30% allocation to investment grade credits, maintains an average credit rating of BB+ with a very short duration of 2.6 years. BM