A simple theory
Einstein’s lesson for investorsRobert Baltzer
The value of any investment can fall as well as rise and investors may not get back the amount invested.
Albert Einstein observed that simple is often best. Here, Robert Baltzer explains why this is true when it comes to investing in high yield bonds.
The phrase “everything should be made as simple as possible, but not simpler” is often attributed to Albert Einstein (although it paraphrases his actual quote). In essence, his observation is that complexity impairs our ability to understand the world. As a result, we should endeavour to simplify our ideas as far as we can without compromising their integrity. This is how we think about investing in high yield bond markets.
© Ernst Haas/Getty Images
Financial markets are complex systems, and our collective ability to predict the future is clearly limited. For all the time spent pondering ‘known unknowns’ – how much gas will Russia supply to Europe? What impact will inflation have on aggregate demand? – markets continue to be surprised by ‘unknown unknowns’ like the Covid pandemic or the invasion of Ukraine. Few could have confidently predicted these events and so, rather than being distracted by the chatter of complex and changing macroeconomic news, we have long advocated a calm, steely focus on long-term return opportunities and company fundamentals. In our view, the best way to deliver attractive returns for our clients in high yield bonds is to seek resilience from our investments. We do this by identifying a diverse range of distinctive opportunities and ensuring the companies in which we invest are robust and adaptable. This is still no easy task, but it is as simple as we can make it.
Today’s environment, characterised by tightening monetary policy, high inflation, supply chain disruption, elevated uncertainty and the resulting increased cost of capital, has been challenging for riskier assets. In the context of the high yield market that means bonds with longer maturities, those that are subordinated, or where the issuers are less mature businesses have been under pressure. We own some of these in our high yield portfolios, and believe these positions continue to offer attractive long-term return opportunities that go unrecognised or misunderstood by the wider market.
For example, we own bonds issued by the UK’s leading independent vehicle leasing, fleet management and outsourcing business, Zenith. Those that take a top-down view might look past Zenith, dismissing it as a small, low-rated business which serves other companies and is reliant on wholesale funding. Unsurprisingly then, Zenith’s bonds have been at the sharp end of the recent sell-off, offering a yield well above similar high yield bonds. As bottom-up investors, we take a different view and believe the valuation has moved out of sync with company-level fundamentals. Zenith has a track record of growth and resilience, along with an experienced and capable management team. It also has the support of banks, which value its expertise and understand its collateral pool well. We believe Zenith will continue to deliver steady and predictable growth as it leverages its well-established customer relationships and pursues an electric vehicle strategy ahead of its competitors.
Another example is the corporate hybrid bonds issued by European real estate company Heimstaden Bostad. The company owns, develops and manages residential homes in markets where there is a structural shortage. These strong fundamentals mean that, while the hybrid bonds are subordinated to the company’s senior BBB-rated debt, we believe the default risk is low. However, the issuer can choose to defer the date at which the principal is repaid, making them highly sensitive to market sentiment and interest rate expectations. As a result, Heimstaden’s hybrid bonds have exhibited high volatility in the past six months.
Ultimately, we believe this company has the financial strength to repay its debt on the expected timeline. Therefore, we believe the BB-rated hybrid bonds offer an attractive yield for the rating and relative to the senior bonds.
As patient investors, we are willing to take meaningful positions in the best long-term return opportunities and look through short-term market gyrations. While the resulting volatility might be uncomfortable at times, experience tells us this is an effective route to delivering outperformance for client portfolios. We’ve made it simple: we are focused, not frantic.
look to the future
Not the past
The views expressed should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.
This communication was produced and approved in September 2022 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.
This communication contains information on investments which does not constitute independent research. Accordingly, it is not subject to the protections afforded to independent research, but is classified as advertising under Art 68 of the Financial Services Act (‘FinSA’) and Baillie Gifford and its staff may have dealt in the investments concerned.
Baillie Gifford & Co and Baillie Gifford & Co Limited are authorised and regulated by the Financial ConductAuthority (FCA). Baillie Gifford & Co Limited is anAuthorised Corporate Director of OEICs.
Baillie Gifford Overseas Limited provides investment management and advisory services to non-UK Professional/Institutional clients only. Baillie Gifford Overseas Limited is wholly owned by Baillie Gifford & Co. Baillie Gifford & Co and Baillie Gifford Overseas Limited are authorised and regulated by the FCA in the UK.
Persons resident or domiciled outside the UK should consult with their professional advisers as to whether they require any governmental or other consents in order to enable them to invest, and with their tax advisers for advice relevant to their own particular circumstances.
Baillie Gifford Investment Management (Europe) Limited provides investment management and advisory services to European (excluding UK) clients. It was incorporated in Ireland in May 2018. Baillie Gifford Investment Management (Europe) Limited is authorised by the Central Bank of Ireland as an AIFM under the AIFM Regulations and as a UCITS management company under the UCITS Regulation. Baillie Gifford Investment Management (Europe) Limited is also authorised in accordance with Regulation 7 of the AIFM Regulations, to provide management of portfolios of investments, including Individual Portfolio Management (‘IPM’) and Non-Core Services. Baillie Gifford Investment Management (Europe) Limited has been appointed as UCITS management company to the following UCITS umbrella company; Baillie Gifford Worldwide Funds plc. Through passporting it has established Baillie Gifford Investment Management (Europe) Limited (Frankfurt Branch) to market its investment management and advisory services and distribute Baillie Gifford Worldwide Funds plc in Germany. Similarly, it has established Baillie Gifford Investment Management (Europe) Limited (Amsterdam Branch) to market its investment management and advisory services and distribute Baillie Gifford Worldwide Funds plc in The Netherlands. Baillie Gifford Investment Management (Europe) Limited also has a representative office in Zurich, Switzerland pursuant to Art. 58 of the Federal Act on Financial Institutions (“FinIA”). The representative office is authorised by the Swiss Financial Market Supervisory Authority (FINMA). The representative office does not constitute a branch and therefore does not have authority to commit Baillie Gifford Investment Management (Europe) Limited. Baillie Gifford Investment Management (Europe) Limited is a wholly owned subsidiary of Baillie Gifford Overseas Limited, which is wholly owned by Baillie Gifford & Co. Baillie Gifford Overseas Limited and Baillie Gifford & Co are authorised and regulated in the UK by the Financial Conduct Authority.
La presente oferta se acoge a la Norma de Carácter General N° 336 de la Comisión para el Mercado Financiero (CMF) de Chile. La presente oferta versa sobre valores no inscritos en el Registro de Valores o en el Registro deValores Extranjeros que lleva la Comisión para el Mercado Financiero, por lo que los valores sobre los cuales ésta versa, no están sujetos a su fiscalización. Que por tratarse de valores no inscritos, no existe la obligación por parte del emisor de entregar en Chile información pública respect de estos valores. Estos valores no podrán ser objeto de oferta pública mientras no sean inscritos en el Registro de Valores correspondiente.
The securities have not been, and will not be, registered with the Colombian National Registry of Securities and Issuers (Registro Nacional de Valores y Emisores) or traded on the Colombian Stock Exchange (Bolsa de Valores de Colombia). Unless so registered, the securities may not be publicly offered in Colombia or traded on the Colombian Stock Exchange. This presentation is for the sole and exclusive use of the addressee and it shall not be interpreted as being addressed to any third party in Colombia or for the use of any third party in Colombia, including any shareholders, managers or employees of the addressee. The investor acknowledges that certain Colombian laws and regulations (including but not limited to foreign exchange and tax regulations) may apply in connection with the investment in the securities and represents that is the sole liable party for full compliance therewith.
The Superintendencia del Mercado de Valores (SMV) does not exercise any supervision over this Fund and therefore the management of it. This document is only for the exclusive use of institutional investors in Peru and is not for public distribution.
The interests in the following securities have not and will not be registered in the National Registry of Securities maintained by the National Banking and Securities Commission, and therefore may not be offered or sold publicly in Mexico. The interests in the following securities may be offered or sold to qualified and institutional investors in Mexico, pursuant to the private placement exemption set forth under Article 8 of the Securities Market Law as part of a private offer.
Information on the relevant LATAM funds is available on request. Please contact [email protected]
All information is sourced from Baillie Gifford & Co and is current unless otherwise stated.
The images used are for illustrative purposes only.
YOU MAY ALSO LIKEInsights.Visit Baillie Gifford's Insights page.Legally Bond: finding underappreciated resilienceBy keeping an open mind, we hope to find opportunities other credit investors might overlook.Actual Income: We need to talk about inflationWhen discussing investing, it's hard not to hear concerns surrounding inflation. Watch this webinar recording to hear some of the thoughts and opinions on this hot topic direct from five of our fund managers.Staying Focused in Frantic Times.In the midst of the pandemic, do Mercado Libra and Avantor's bond offer long-term value?