Vikas Vashishtha, Fixed Interest Analyst, Emerging Markets and Credit
Credit is the lifeblood of economic activities of businesses, governments and individuals. Prior to the GFC, banks were the dominant providers of credit. Commercial banks extended loans and investment banks underwrote debt securities. This system worked well for decades. It brought down the overall cost of credit and lubricated businesses.
However, parts of this system went too far in the last decade with loose underwriting of subprime mortgages, mainly in the US. We are all familiar with the aftermath. Global banking regulators responded with sweeping rules, some of which are still being written and implemented. While there is little reason to sympathise with banks, it is worth mentioning that a lot of their activities were actually useful for society at large. Most of the regulations are designed with the intent of creating a more robust financial system. However, some parts may unintentionally ruin some of the positive effects.
Basel-III1, which consists of rules by an international supervisor, provides an example. It makes higher yielding credit far more unprofitable for banks. This means while budding ventures may find it harder to access capital, well-rated big businesses can borrow more than they really need. For instance, in recent years large multinational companies have engaged in stock buybacks funded by cheap credit. Other set of regulations such as Dodd-Frank or Volcker Rule, have a few similar unintended consequences for business activities2.
A good venture is good venture, irrespective of the source of its capital. Although some companies, governments and projects have lesser access to capital, it does not mean their ventures are less worthwhile. In fact, investors including Funds like ours are likely to be rewarded more than they would have been in the past.
One of the challenges for us while approaching credit as an investment is that most companies and projects are financed via equity apart from credit. The QSuper portfolios3 have plenty of the former, so credit investments offer incremental benefits when they are meaningfully different to equities and/or have potential for good risk adjusted returns. Higher-yielding bonds of some governments form one such bucket. We remain vigilant to similar possibilities.
1. http://www.bis.org/publ/bcbs189.pdf. Basel Committee on Banking Supervision
2. https://www.imf.org/external/pubs/ft/wp/2014/wp1446.pdf. The regulatory response to the Global Financial Crisis (IMF)
3. The term ‘QSuper portfolios’ is used to refer collectively to the underlying portfolios of assets which in combination make up the individual asset allocations of QSuper Lifetime and the Balanced, Moderate and Aggressive investment options.
The views of the author and those who provided the responses to the comments posted on this blog are not necessarily the views of the QSuper Board. We’ve put this information together as general information only and as such it doesn’t take into account your personal financial objectives, situation or needs. You should get professional advice before relying on this information.
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Fixed Interest Analyst – Emerging Markets and Credit
Vikas’ role involves analysis of credit and EM bonds within the fixed interest asset class in the investment strategy team of investments division.