Earlier this year, the bond market was turbulent between geopolitical tensions and rising interest rates. In an uncertain and volatile environment, Michael Israel, co-founder and manager of IVO Capital Partners, a management company specializing in emerging markets, shows his confidence.
What is the impact of the war on IVO bond reference funds?
The effects of the war in Ukraine remained limited to our flagship fund. Prior to the invasion, Ukrainian companies accounted for about 6% of the portfolio. Due to their poor reputation, they represent 2.5% today. Moreover, there was no contact with Russian companies that had fallen even sharper. Fortunately, we are much more exposed to Latin America. Because Latin America is a “commodity” continent, it is a region that is benefiting from the current crisis. Portfolio companies, which had already achieved strong growth before the war, have achieved remarkable results for several weeks thanks to soaring prices. We are targeting companies that generate significant “free cash flow” and reduce leverage very quickly. In 2021, the high-yield bond market developed with spread compression in the United States and Europe, but in emerging markets, despite good performance, this compression was not seen. The dichotomy that did not prevent our flagship fund from recording 9% performance last year.
How do you explain investor distrust of new debt?
Beside the elephant in the room! Investors played safely given the Fed’s outlook for rapid monetary tightening and concerns about growth in China, a major emerging market. This distrust has given us the opportunity to acquire very high quality corporate bonds at an affordable price. This disconnect between very positive microeconomic data and macroeconomic fears continues this year. Our portfolio company has never been so successful. For example, companies in the portfolio have doubled the value of their stocks since the beginning of the year, but bonds remain very attractive. Moreover, while emerging debt remains highly correlated with US interest rate trends, interest rates in the three and five years have risen significantly in recent weeks. What are the short-term factors for emerging corporate bond prices? US rates, ratings, macroeconomics. Since the microphone only comes last in the current environment, there is a lag available.
How do you build your portfolio?
We continue to support not only low-debt companies, but also those related to commodities. These companies are rare winners in this very special situation of very worrisome stagflation. In addition to being a direct beneficiary of rising prices, they are less exposed to the European economy, the most endangered region. European companies in the high-yielding segment benefit from an average adjustment of nearly six times Ebitda, compared to 1.9 times that of emerging markets. Keep in mind that a typical problem for businesses to take advantage of this important advantage is to have too much debt on their balance sheet as the cycle changes. This is not the case for our investment universe.
It’s important to remember that start-up bonds have the advantage of offering high yields in the euro, in addition to low debt and good sectoral and geographical locations (depending on today’s funding). Between 7.5% and 12%). .. This constitutes an important level for investor capital protection, as high yields are also a way to protect fixed income portfolios in the event of increased defaults.
Finally, we are in a short-term position (between 2.5 and 3.5 depending on the fund). This allows investors to invest in asset classes that not only provide adequate protection in the monetary tightening cycle, but also provide mathematical visibility into the risk of interest rate sensitivity. Not so obvious in other asset classes.
The investment theory of the fixed income universe varies greatly depending on the segment selected. A 10-year bond with a yield of 1% is clearly much more risky to rising interest rates than a 3-year bond with a yield of 7%, especially if the company in question has little debt.
Interview with Pierre-Jean Lepagnot