Whither credit when debt is a four-letter word

The slow-moving train wreck that is the credit crisis has no end in sight, the president of Augustus Asset Managers, Edward Dove, told the Absolute Returns Conference, but fear is throwing up opportunities.

With the turmoil in the world’s banking system leading to a sharp deterioration in credit markets, and the banks’ ability and willingness to lend being undermined, Dove said the banking crisis is not over yet and the impact will linger for some time.

But this means that now is the time to be selectively adding credit risk, providing investors are able to take a medium-term view. Dove told delegates opportunities in fixed income are reappearing as hedge funds deleverage due to a lack of available credit. “Banks have still not covered their write-offs and the US home equity lines of credit sector continues to pose a significant threat,” he said. “Buyers of corporate debt, particularly in the US, have disappeared. What is happening in corporate debt markets presents wonderful opportunities and in particular it is a good time to be selectively adding credit risk.”

He said corporate bond spreads are almost at the levels of the third quarter 2002, and investment-grade debt has to be put into portfolios now. This strategy received agreement from Thomas Strauss, founder and chief of hedge fund manager Ramius, who said senior bank debt has not stopped looking attractive through the current crisis. However default rates are expected to go into double digits, so Dove believed it was too early to buy high yield. Dove said investors should be short credit strategies (names not indices), short duration investment grade credit, short sub prime-debt (the crisis in which is nowhere near over), while emerging markets sovereign debt presents fair value, although he added emerging markets foreign exchange offered better opportunities.

According to Dove, traditional long-only strategies are not positioned to take advantage of these conditions, because of the beta component, so investors need to look at absolute return bond strategies, such as a long/short fund, that have low correlations and are unconstrained. The likely outcome of the current crisis, according to Dove, is an aversion to credit the same way there was an aversion to equities after the dot.com bust.