Joost de Graaf, head of credit and portfolio manager of the Kempen Euro Credit fund, discusses generating consistent alpha through selective, bottom‑up investing and how to be resilient in tougher markets.
The Monday Manager series covers fund managers that have worked on their fund for over three years, and where fund assets are over £100m.
Can you explain the fund’s approach to investment and what it is trying to achieve for investors?
Our aim is to consistently generate alpha for clients relative to our benchmark, the iBoxx EUR Credit Index, without taking undue risk. This means we do not seek to maintain a persistent long-beta position; rather, we focus on generating alpha by consistently investing in bottom-up opportunities.
For example, this may include issuers with an improving credit profile that are not yet fully priced by the market or bonds that trade attractively relative to their own issuer curve. This approach has enabled us to generate attractive alpha with a low tracking error, which in turn translates into strong information ratios. It also means the fund is well-positioned to outperform more risk-seeking peers during periods when markets are more challenging.
Which areas of the European credit market are you most excited about right now, and which are you avoiding?
Spreads are tight at the moment, and dispersion within the market is limited. As a result, we are now more than ever focused on finding bottom-up opportunities to generate alpha. That requires a truly active approach, grounded in a deep understanding of the companies and securities in which we invest.
For example, we invest in a small bank that had faced issues with its certificate holders and with certain loans it had made. The bank has since resolved these issues, but the bonds have not yet fully responded to this favourable development.
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Another such example is the hybrid bonds we bought from a US-based consumer staples company that had to shore up its credit rating and had to offer relatively high spreads to attract investors. We also have a sizeable position in a state-owned grid operator that has both, government-guaranteed bonds outstanding and non-guaranteed bonds. These non-guaranteed bonds are trading attractively as the credit risk is also minimal.
Given current spread levels, we prefer opportunities where we believe the risk-reward is clearly identifiable at the issuer or bond level.
There’s a huge amount of interest rate uncertainty right now. Has this affected your positioning? If so, how?
We have intentionally chosen not to play the interest rate game. Instead, we aim to maintain duration broadly in line with the benchmark and do not take interest curve bets. The higher yields we see now compared to five years ago have attracted many new investors to the asset class which is positive on multiple fronts. Notably, it means the credit market is growing and with that, is becoming better equipped to help finance the large global capex needs the world has such as the build out of AI infrastructure and the energy transition amongst others.
Looking beyond politics and over the longer term, what are some of the biggest headwinds investors in European credit have to contend with right now? How are you mitigating these?
The current environment for credit markets is favourable and this is reflected in the relatively tight spreads we see today. Economies are generally in good shape, supported by resilient growth and low unemployment. Corporates are generating record profits and the banks, particularly in the US and Europe, remain very strong.
Economic activity is also being underpinned by the AI infrastructure build-out, the energy transition, commitments to invest in defence and large infrastructure programmes and, over the longer-term, the food transition.
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At the same time, these initiatives need to be financed, which in turn means they have contributed to higher inflation and interest rates. What is not helpful is that governments are generally running deficits that are too high, combined with limited political will to get them under control. Additionally, there is meaningful divergence beneath the healthy global growth picture, with some countries reflecting much weaker economic conditions.
We keep this in mind and seek higher spreads from issuers based in countries with weaker economies and government finances. The higher risk of investing here must be coupled with the potential of greater returns and if not, we are happy to be underweight or not invest at all.
The same goes for issuers that are potentially negatively affected by AI. They can still represent attractive investments when spreads are high enough. However, if spreads do not compensate for the risks, we are comfortable not being involved and looking for opportunities elsewhere.
What is the benefit in investing in European credit, as opposed to credit from other regions?
For large global investors, there are really only two credit markets that are large and liquid enough: the USD and EUR credit markets. Both offer the required diversification and depth to issuers and investors alike. In these markets, it is possible to invest €1 to €3bn in a single day and have a broadly diversified portfolio, which is not the case for the credit markets of other currencies.
That said, for local investors these markets still present a strong appeal given the currency risk is low and, in general, they typically receive a slightly higher spread as compensation for the lower liquidity.
Geopolitical considerations have boosted the appeal of the euro market over the past year. In our view, it carries less risk from political interference or broad-based taxes that target foreign investors.
What is the best piece of investment advice you have ever been given?
For the bond market specifically, the best piece of investment advice I have received is that there are no bad bonds, only bad prices. If a bond’s price is low enough and its spread wide enough, that valuation can compensate much of the risk you face as a credit investor.