Pioneer: In at the deep end

Pioneer Investments has launched a new fund into the burgeoning but turbulent subordinated bond markets. Pioneer portfolio manager Vianney Hocquet explains how, leveraging off the firm’s experience in the asset class, the fund aims to reduce volatility through fundamental stock-picking and proactive asset allocation across financial and non-financial hybrids.

What was the rationale for launching the global subordinated bond strategy?

Vianney Hocquet, Pioneer Investments: The key aim of this strategy is to allow investors to target returns comparable with those of high yield issuers, investing in subordinated bonds issued by investment grade-rated companies and banks. The current yield environment, depressed by monetary stimulus from the largest central banks in the world, is supportive of a strategy providing a yield pick-up over traditional credit.

The subordinated debt market has increased in size and diversification over the past few years and continues to grow considerably due to the combination of increased demand from investors and desire for corporates to protect their rating (for corporate hybrids) and regulatory-driven issuance on behalf of banks (for financial subordinated debt).

This strategy leverages on the skills and track record of our credit portfolio managers and credit analysts in successfully investing in subordinated debt globally. This is, in our view, one of the key features of the portfolio, as it allows our portfolio managers to leverage the best ideas of our credit analysts globally without the need to remain invested where we feel the risk-reward not to be compelling enough, and to receive the extra yield from the subordination premium where it is the most attractive. This flexibility allows us to invest in any new structures that might arise in the future — but more importantly does not force us to remain invested in an unappealing asset class/industry/geography due to mandate limitations.

Lastly, this portfolio is managed without any active currency risks. The portfolio currency is euros – and any bond denominated in a non-euro currency is immediately swapped into euros before entering the portfolio. We believe this offers investors the benefit of geographic, structural and sectorial diversification without incurring “implicit” currency risks. As with all Pioneer Investments’ products, we can offer solutions for investors who do not want to have euro risk in their portfolios.

Pioneer Investments has been managing dedicated segregated accounts in the subordinated bonds space for more than four years, with a strong track record, and we have been actively investing in these type of securities in our flagship credit strategies for an even longer timeframe, particularly when considering the so-called “old style” bank capital, which we have been involved in for a very long time.

Our credit analysts can invest and have been investing across the capital structure of both non-financial and financial issuers, and in the case of the latter we’ve been also very selectively playing the new bank capital instruments introduced by the Basel III Bank Capital Directive.

What does the investment strategy involve?

Hocquet, Pioneer: This strategy combines a strong top-down investment approach by our portfolio managers with a fundamental bottom-up stock picking of subordinated bonds by our global credit research team.

The top-down investment is an asset allocation decision by the portfolio managers, who allocate across the corporate hybrids and subordinated financials space based on valuations, technicals, outlook and risk profiles of each asset class globally.

The bottom-up selection includes the top-picks — taking into account both the credit profile of the issuers and the legal characteristics of the bond language we invest in — of a team of 25 career credit analysts globally. Our analysts, like the portfolio managers, have a very long experience analysing and investing in subordinated bonds across the European, US and emerging markets — and they look at both investment grade and high yield-rated securities.

It is our strong conviction that the subordination risk embedded in these securities can be mitigated and contained through a strong fundamental analysis and a thorough assessment of the clauses in the offering documents.

What size of assets do you have dedicated to this strategy?

Hocquet, Pioneer: Our clients have already entrusted us with a bit more than Eu300m since the launch of this strategy in December 2015. This remarkable commercial success is a testament to the good track record our analysts and portfolio managers have investing in these asset classes — particularly in the currently depressed yield environment. We also manage more Eu2bn in this space between our flagship credit strategy and segregated accounts.

Despite the volatility incurred in the first few weeks of the year, it is our strong conviction that investors in this asset class can benefit from high carry and target mid-single digit returns over the medium term — and more importantly that a proactive asset allocation between corporate hybrids and financials subordinated debt (the former having a more defensive profile than the latter) across sectors and geographies can smooth volatility and add much needed diversification for investors.

Is there a total return target for the fund or a benchmark reference?

Hocquet, Pioneer: We measure the performance of this strategy against a mix of 35% Global Investment Grade Non-Financial Hybrids, 15% Global High Yield Non-Financial Hybrids, 25% Contingent Convertible Bonds, and 25% Preferred Shares.

We have a single-digit total return target for this strategy, which compares favourably with Euro Credit (particularly so with Investment Grade, where in our view the default risk is similar to the bonds we hold in this strategy).

It is our policy to set targets that are realistic and ambitious, but to give our analysts and portfolio managers a higher target, which we think they can achieve.

Are there any particular regions/sectors/products that the strategy is currently focused on?

Hocquet, Pioneer: The product does not have a focus towards any specific regions/sectors/products. The product leverages very experienced portfolio management and credit analysis skills Pioneer Investments has across our three global investment hubs of Dublin (where both lead portfolio managers are based), London and Boston. The strategy seeks to be flexible — the only constraint we have is that a maximum of 75% of the portfolio can be invested in financials bonds.

Subordinated markets can and have been very volatile, how will the strategy manage such risks?

Hocquet, Pioneer: We believe that the combination of fundamental stock-picking and a proactive global asset allocation can reduce the volatility of the portfolio. We aim to address the volatility by focusing on the best risk-reward bonds across the global subordinated space — both in the financial and the non-financial space.

While liquidity can diminish significantly when investors become concerned about one particular issuer, we believe the asset class is liquid enough and more importantly a dedicated strategy such as ours can properly exploit any market dislocations and mispricing arising from any of these liquidity-driven movements.

Lastly, while we use a large array of tools to manage volatility (for instance options, Index CDS), we invest across the curves of the issuers we like and try to have as diversified an exposure to names we like, we can allocate to corporate hybrids or financial subordinated bonds (the former tends to be a more defensive asset class and outperforms financial subordinated in a risk-off market), these instruments tend to have a higher beta than the senior credit — and therefore higher volatility (and possibly return) should be expected by investors in any such products.