Higher concentration risk means a greater probability of significant loss if a company or sector runs into difficulties. For instance, at the beginning of 2024, the biggest constituent of the UK water utility sector represented around 1% of the sterling credit market—and since the summer has been downgraded by over seven notches from investment grade to deep high yield.
Most UK sterling bond portfolios had at least some exposure to this issuer because of its size in the Sterling Index, and as it fell from investment grade their losses were increased by the lack of liquidity in the sterling high-yield market, which is valued at just £37 billion versus euro and US dollar peers at €384 billion and $1.4 trillion respectively.
Deeper markets with larger buyer bases provide a smoother transition from investment grade to high-yield status; by contrast, the small size of the Sterling Index made it much harder for such a large downgrade to be well absorbed.
Greater Diversity Means Wider Opportunity
Active fixed-income managers aim to add value by taking views on a variety of factors besides individual security selection. These include sector selection, interest-rate risk (duration), credit risk and sensitivity to market changes (beta). With a global mandate, managers have maximum flexibility to implement their views across yield curves, credit ratings and currencies, choosing from the widest possible range of securities to seek improved performance and risk outcomes.
One attraction of the sterling market is that it provides access to long-dated bonds. But that’s not a unique feature, as debt markets in the US—and increasingly the eurozone—also include a large pool of long-dated issues. Hence, mandates based on global markets can offer the same advantages as sterling, and with more flexibility (Display).
