Our credit strategies involve three main decisions:
- How much to allocate between federal government bonds, provincial government bonds, and corporate bonds. Within corporates, how much to invest in each specific industry.
- How much to allocate to highly-rated securities, medium-rated securities, and lower-rated investment grade securities.
- How much to allocate to specific issuers, whether the federal government, a province, a municipality, or a company.
Sector allocation is a combination of a top down research and bottom up research. We determine which sectors we believe will outperform based on our macroeconomic outlook. We prepare a valuation of each sector to decide whether there is any value for us to allocate some of the portfolio to that sector given various risk parameters.
We look at the overall credit rating of our portfolio (based on our own internal research) and compare it to the market’s implied rating to determine the gap. For example, if we believe a bond to be rated AA but the bond market prices it to a level equivalent to a BBB bond (an implied rating), then we consider that bond to be undervalued. If, on the other hand, we judge a bond to be rated AA but the implied rating is AAA, that bond is overpriced in our view.
When deciding which company’s bonds to buy, we develop our own fundamental assessment of individual industries and issuers. This involves contact with management, FGP’s equity research analysts, external research analysts, and credit rating services.
We review a company’s business plan and strategy. We also look at factors external to the company:
- Market dynamics
- Number of competitors
- Drivers of earnings
- Industry trends
We then look at the company’s liquidity to see if it has the ability to pay back its loans. We look at the company’s balance sheet where the most important factors to consider are current and fixed assets rather than goodwill and other intangibles. Finally, we look at the company’s earnings to try to determine future weakness or improvement.
To come up with a more complete picture of a company, our fixed income analysts seek input from their equity counterparts when assessing an issuer. They also participate in meetings with company management jointly with the equity team if they are following the same company.
If we like the company, we will closely examine a specific bond issue’s:
- Credit enhancement or support
- Ranking in the capital structure
We make sure to buy bonds with optimal risk/return characteristics.