Global Credit Income Strategy

Bonds in a UK-based airline had been held in our global credit funds for a few years. Earnings in the airline sector can be volatile due to fluctuating fuel prices and demand, but the bonds offered reasonable value for risk, in our view.

A US-based conglomerate has been beset by questionable corporate governance practices, lack of transparency and a string of unexpected strategic announcements. The broader market appears to have extended the company some goodwill due to its ‘brand name’ rather than assessing the firm on underlying facts, though this appears to be changing gradually. 

Our ESG risk rating on the company was initially raised in late 2017 and again in late 2018. Consequently, internal credit ratings have been consistently below the external ratings agencies. Our assessment on the credit and ESG risks, along with uncertainty on the company’s strategy and future credit profile prompted us to sell bonds in our global credit portfolios. 

Risk assessment:

- The conglomerate reduced the size of its Board amid significant operating deterioration, underlining the governance risks present. There have been repeated changes in leadership, which disrupt the business and can result in continual shifts in company strategy. Repeated negative surprises and management changes are red flags in terms of internal controls and suggest a lack of cohesion in strategy. Accordingly it is difficult to envisage what the company might look like in the medium term. 

- Our greatest concern is that cash flow will be insufficient to service the company’s enormous debt load. At this stage we are unconvinced that the firm’s current plan to retain the Power, Renewable Energy and Aviation subsidiaries – along with parts of the financial services division of the company – will remain intact. This is a serious concern from a credit perspective as underlying businesses face serious headwinds and as management priorities are spread thinly. Further, this other division of the company's debt is now guaranteed by the parent. We think the financial services division could be breakeven at best and could require significant capital contributions in the near term. 

For illustration purposes only. Reference to specific securities (if any) is included for the purpose of illustration only and should not be construed as a recommendation to buy or sell the same. All securities mentioned herein may or may not form part of the holdings of First Sentier Investors portfolios at a certain point in time, and the holdings may change over time.

Due to a number of environmental, social and governance concerns, our internal credit rating for a Japanese automobile company has been below those of the major rating agencies for several years. The ratings agencies themselves have started to downgrade their ratings and outlooks for the company, moving more in line with our internal credit rating.

Risk assessment:

- The company's oversight of employee safety and supply chain social responsibility is relatively weak, in our view. Operations in emerging regions mean social and work force relations issues are often present for carmakers and there is an ongoing focus on safety and supply chain management in the industry. 

- In some cases there can be complex shareholder structures to contend with, resulting in additional governance risks. In this company’s case, a structure of cross shareholdings exists between three other automobile companies. This undermines the governance profile of the company, highlighted by a recent scandal. The former Chairman/CEO was arrested on various charges of financial misconduct, including misappropriation of funds. 

- There are also question marks over the company’s internal quality control systems given frequent safety issues and recalls. Recently the industry regulator discovered that unauthorised inspectors had been approving vehicle quality, resulting in a recall of 1.2 million vehicles in Japan. There have also been allegations of anti-competitive behaviour and misleading claims – a red flag from a governance perspective.

- The global auto industry is evolving, partly reflecting environmental risks and trends. Increasing consumer awareness of pollution has resulted in rising demand for cleaner and more efficient vehicles, including fully electric models. The company has produced more electric vehicles than many peers, but volumes remain low relative to total production.

For illustration purposes only. Reference to specific securities (if any) is included for the purpose of illustration only and should not be construed as a recommendation to buy or sell the same. All securities mentioned herein may or may not form part of the holdings of First Sentier Investors portfolios at a certain point in time, and the holdings may change over time.