Episode Transcript
Speaker 1 00:00:05 Hello everyone, El welcome to the Loan Stock Exchange, dead Capital Markets Deep Dive series. This is our second session, which is a quarterly examination of key fixed income issues that have impacted the market. I'm delighted to be joined today by an expert in fixed income investment, David Kambo, who is a senior fund manager at Ed Entry. Good morning, David. Hi,
Speaker 2 00:00:31 Morning O
Speaker 1 00:00:34 Very nice to have you on today. So David, you and I, um, today we are going to, it's essentially take a look at the global macro economy from the perspective of the US market and see, look at how the difference between the US economic landscape and the European economic landscape can create opportunities for, um, issuers, but also for investors like yourself. So we've been following, um, the development from central banks, um, in the last few months as they move interest rate as a way to tackle inflation. And we've seen that the fed in, in increase our interest rate earlier in June. Um, we've obviously heard the news last week that the ECB also increased their raise by 50 basis points. So while there seemed to be a consensus in rising interest rate, there is, however, a different approach between what we see in Europe and what we see here in the US with the federal reserves, um, being a bit more hawkish, um, than the e cb. So my question to you is, why are we seeing such a different approach in tackling inflation? In other words, how can we explain that gap between interest rate between the US and Europe?
Speaker 2 00:01:52 It's a good observation or, um, you know, central banks globally are moving at, um, different, um, pace in tightening. They're both, um, moving the same direction are either e ECB and the Fed. But, um, understandably the e ECB is also looking at growth and is more sensitive to growth. Um, there is a war, um, taking place, right on its full step between, um, Ukraine and Russia, which has growth implications as well. Um, not only on energy supply, but also on economic growth and also production. And so the E C B has to keep one eye on the growth consequences of that geopolitical situation as well as wanting to tackle, um, inflation. It does want to raise rates. And indeed that 50 basis point rate that you mentioned is evidence of doing so. But you could say the terminal rate is going to be lower because of its concerns around the growth, um, side of the equation whilst the Fed doesn't necessarily have that, that particular challenge.
Speaker 2 00:02:50 And so it's, it's, um, concerns a more domestic tackling inflation, um, there. And so as you see, um, you know, center bank leaning more towards, um, growth i e the E C B, you could have a wider disparity in those interest rates going forward, especially now that, um, rates rises are coming through at a faster clip, you could say in the US compared to, um, Europe, I think the US is widely expected to raise rates by 75 basis points, whereas Europe, um, has done 50 thus far and is likely to move at that kind of clip, if not, um, lower than that. And so broadly I'd say, um, it's that sort of, um, interest rate hike, um, differential and that likely to stay.
Speaker 1 00:03:34 Okay. So, you know, if, if I'm, I'm understanding correctly then your, your perspective, you know, looking sort of shorter to medium term is that that gap will actually widen between what we see in Europe and what we see in the us.
Speaker 2 00:03:48 There's a chance yes, that that sort of stays like that. I mean, who knows where inflation will peak? Very likely it could even head to double, um, digit levels. Now, if you have a bank that is less concerned about growth or indeed wishes to sacrifice growth, it can be much more aggressive in terms of rate, rate hikes and also end up at a much higher, um, terminal rate level, that bank being the fed. Whereas the E ecb, um, wouldn't necessarily have, um, such a, a luxury if you like. And if there's a further point to be added here is that the e ecb setting policy for, um, a number of member states rather than a single um, economy. And that in its own, uh, poses some challenges and you could say, um, might limit the aggression within which it can raise, um, rates as well. But short-term to medium term, it's very likely you're going to see, um, the states continue at that faster clip and therefore widening differential.
Speaker 1 00:04:46 So looking at like market activity over the last few months, obviously there's been, you know, a lot, lot of sort of challenge, um, on the market. Market conditions have been, you know, very volatile. However, we continue to see an increase of US corporates choosing to issue in a European market rather than a domestic US market. This is commonly referred as reverse Yankees. And presumably this is to take advantage of this rate differential. So for example, we've seen in May we had two investment grade, uh, credit that came to market. We had McDonald's who issued a Euro and a sterling, um, Deni denominated bonds visa also issued a, um, euro bonds. And then more recently in July, we saw that Pepsi tapped the European market with a sterling, um, benchmark bonds. So from your perspective, as an investors who, um, invest predominantly in Euro and Sterling denied bond, you know, what tends to be, um, the rational order strategy followed by us, um, corporates to tap into the European market. Is it to take advantage of interest rate differential? Is it to diversify investor base? What's your experience, um, in, in as an investor buying these bonds?
Speaker 2 00:06:07 I think having spoken to corporate treasurers, bringing these bonds to the market, um, it's a combination of both those things. Odd, um, in terms of the funding costs that they're able to achieve in Europe when it's been at negative interest rates for some time, there's a clear, uh, benefit i e from a funding point of view, even after hedging of issuing in, in euros, especially on your funding projects, um, locally hedging your, your currency risk like that. But there's also diversification benefits. Um, even though they have a big domestic market, they still want to tap into other pools and broaden the set of investors that they're accessing, broaden the pools of capital that they're accessing, whether that's via Sterling or whether that's via, um, Euro as well. And so both those factors, um, featuring quite, quite prominent in that rationale for them coming, um, to this market.
Speaker 2 00:06:55 From our side, I suppose as investors, we're also very keen to diversify our underlying portfolios, and that not only means on a sector term structure, credit rating point of view, you're also looking diversify that geopolitical, sorry, that, um, underlying economic risk. And so, um, whether it's, um, issuing or rather buying companies that are based, um, in the US rather than all being, um, newer or sterling, um, that also helps in terms of portfolio diversification. And, um, that diversification point I think goes, um, two ways, but from their, um, point of view, i e the issuers, um, it's, it's really that divers diversification that the after plus the funding costs benefits that, that they realize in issuing, um, in Euros that, that they obtain.
Speaker 1 00:07:42 Thank you very much. I think that's, that's very clear. Um, you know, as to the reasons for corporates to expand their invest base be beyond their domestic markets, um, as a way to maybe diversify fundings but also additional liquidity. And I I just wanted to to maybe just talk about liquidity a little bit because that's obviously a word that matters a lot to any corporate treasurers trying to raise foreign on a debt market. So here is sort of my question to you. A, um, given the size of the North American market as in investors, do you think there are liquidity advantages for US issuers to tap into, uh, their market outside of their own sizable domestic market?
Speaker 2 00:08:24 I think there are clear liquidity advantages for US issuers coming to issue in Euro, but it doesn't just stop at liquidity. I'd say it also extends to regulatory oversight and the transparency that that comes with that, the visibility that comes with that. And so for investors such as myself, for instance, who have to invest the bulk of their portfolios in approved securities, one of the requirements for approval there is a listing requirement. And with listing requirement comes, you know, financial disclosure requirements and even climate related, um, disclosures of late. And so you really want to make sure that, you know, when you're investing insecurities, the bulk of your portfolio have these minimum disclosure requirements. And when you have US issuers coming to, um, the European market and listing their securities, um, here you can sort of rest assure that from a regulatory point of view they have, um, these disclosures in place. And so that's one way that, you know, the companies themselves can also benefit by increasing, um, their profile from a disclosure point of view, um, accessing a wider, um, you know, universe of investors. And so not just liquidity, but there's other, um, benefits regulatory being, being the other as well.
Speaker 1 00:09:41 Yeah, I think it's an interesting point that you're making around, uh, regulatory difference because that's something that we come across quite a lot here. So, um, you know, the, there's a slightly difference between the domestic US market and what we see in Europe when it comes to bond issuances is that, um, in the US in a domestic US market bonds, corporate bonds tend to not be listed because it's not an investor requirements. However, if you tap into the European market and even beyond that, you know, the Asian market, um, there is, um, sort of a requirement from fixed income investors to have the bonds listed on a recognized exchange so they can actually buy the asset. And that's, I think that's, to me that's a major difference between the two markets. Um, and so US corporate issue is wanting to access this wide pool of investors, have to go through sort of the motion of, you know, listing the security.
Speaker 1 00:10:35 Um, but you um, David, you mentioned sustainability, right? Um, and I know that ED entry is obviously pioneer in sustainable investing in investing, having launched one of the first ethical equity funds in the UK back in March, 1988 <laugh>. So a a while back, obviously. Exactly. Um, <laugh>, so as you know, the loan stock exchange operates, um, our sustainability bond market, which Essent essentially is a market that enables all issuers from all parts of the world, um, to raise sustainable debt financing by targeting fixed income investors with a dedicated E S G mandate. So looking, again, looking at the US market, um, you know, what I'm hearing here in what we see quite a lot now is a rising interest from corporate treasurers to really stay ahead of the E S G curve and fund their strategy through, um, accessing E S G investors based in Europe. And it's fair to say that when it comes to E S G, whether it's on the sort of taxonomy or investor appetite or even level of sophistication from investors, Europe is a far more advanced market. So as the portfolio manager of an impact fund, do you see the same trends of the development of ESG commitments coming from the US and you know, from your perspective, are there more advantages in issuing E S G labeled debt in Europe than in the us? What, what's your view on that?
Speaker 2 00:12:09 Yeah, uh, maybe just worth clarifying as well, we've issued other funds, um, since, so the bond funds, um, 2008 styling bond fund ancho did bond fund 2017 more recently. Global Impact bond fund as you mentioned, um, there, that was this year. Um, but just also taking it a step back in terms of the issuance of, um, these bonds. I mean, if you look at the sort of index that the global impact bond fund is benchmarked against and is sort of dissected by currency exposures, you find that European denominated securities account for about 60% of that index versus 30% from US dollars. So there's a clear, um, you know, period where, um, you know, is E S G issuance was ahead, um, especially in the green social, um, sustainable space in Euros. Um, you know, for investors such as ourselves that are responsible, it gives us an opportunity to interact, um, with issuers to make sure that, you know, our pressing home, um, them, um, accounting for these material e s G risks as best they can, but also from their side, it allows them to sharpen, um, their toolkit in so far as e sg awareness is concerned or along their E S G journey, pushing them further than if they were just, um, issuing in the US because the audience we believe in in Europe is much bigger.
Speaker 2 00:13:26 ESG is higher on the gender as, as you mentioned there. And so these sorts of investors, even mainstream investors, not just um, E S G investors, um, will be much hotter on E S G issues and also encourage best practice. Um, you know, we engage a lot. We, um, seek to catalyze best practice amongst our, our sort of entities that we learn to. And um, really that's the advantage, um, that they're getting, um, by coming to these, these shores and, um, issuing here.
Speaker 1 00:13:56 Understood. So my final question to you then would be, you know, putting your portfolio manager hat on is what is your investor appetite for this increase, um, of US debts coming to the European market? You know, is it something that you would like to see more of to be able to invest? And if yes, would you like to see it expand to, you know, maybe broaden the universe of issuers that we see? Cuz obviously we see quite a lot of, you know, investment grade name coming out of the us but there there is also the high yield universe, there is also the municipality, um, universe as well. So what, what's, what would be your appetite for risk in these asset class?
Speaker 2 00:14:35 Yeah, no, as as an investor, as a PM I'd say I'm biased, obviously what's responsible and impact. Um, and so more e sg labeled issue and certainly is welcome, is always welcome. Um, any portfolio manager would still want to diversify their fund, uh, by high yield or by sector. And so that allows for better portfolio diversification. And so again, more issuance there, um, is of uses. But insofar as, um, the E s G journey is concerned and that that labeled, um, issuance point there, um, it's worth stressing of course. Um, at the very beginning, ma Laters led the way corporates then picked up. Um, governments are very well placed to issue because of the size of issuance that they need to, um, you know, that they can, um, generate and in effect more funding needs to go into that transition towards a sustainable economy, some of which will come via, um, bonds such as these.
Speaker 2 00:15:29 And when you look at governments, you look at local governments, you look at municipalities, a lot of what they do creates social impact, has social impact. And so seeing more issuance from them not only allows for diversification of the portfolio, but also allows investors such as ourselves to generate, um, more social impact if you like, um, by deploying funds into bonds, um, such as these. So certainly a long, um, wishlist, but definitely more issuance, more that is impactful. And we believe that that opportunity exists with examples such as, um, Munis, but also, um, governments and other corporates as well.
Speaker 1 00:16:07 No, that's interesting because actually when you look at, um, the issuance e s g debt issuance coming out of the us, um, you'll find that the, actually the largest portion of the E S G debt is actually issued by us Munis. And as you say, particularly they're very strong in a social social side where they issue quite a lot of social bonds. So it would be certainly good to see that maybe expanded to, um, the European market. Um, but thank you David, thank you very much for this, um, very insightful chat. Um, I thought thank you. It was very interesting. It's very nice to see you and hopefully we'll get to see you, um, here in New York or, um, back in London. So this ends, uh, the second deep dive, um, session. We hope that you find it very interesting and that, um, along with all the work that we do at a loan stock exchange, um, in facilitating the flow of global capital between investors and issuers, you can read up our thought leadership, uh, paper that will be published on the loan stock exchange.com. And in the meantime, we look forward to you speaking with you next time.
