Andrew Kronschnabel has more on his mind than rising interest rates in the U.S.
With the odds of a December Fed rate hike at 91.5%, according to CME’s FedWatch Tool on Nov. 20, the markets are already prepped.
If the expected hike happens, “we don’t expect much volatility in the market,” says Kronschnabel, portfolio manager at Logan Circle Partners in Philadelphia. He’s co-manager of the Renaissance U.S. Dollar Corporate Bond Fund.
When positioning his portfolio, interest rates play second fiddle to other factors. That’s because it’s difficult to “consistently generate alpha” from interest rates, he says. So, “We don’t typically have large duration positionings within our portfolio.”
Instead, his firm sources alpha “from security selection, sector rotation and, to a lesser degree, quality rotation,” he explains. To help with bond selection—both investment-grade and high-yield—the firm’s analysts provide research.
Still, it’s important to monitor interest rates.
“We do have opinions on interest rates,” says Kronschnabel. “Even though we don’t express them in a large way in our portfolios, […] we do manoeuvre around the edges.”
For example, in response to the flattening bond curve this year, his portfolio is overweight at the long end and underweight at the short end. With U.S. rates expected to continue rising, “we’ve seen the Treasury curve flatten pretty dramatically,” and that’s affected everything from the two-year to 10-year point, and even out to the 30-year point.
He adds he’s “slightly short duration.”
His outlook on interest rates is steady as she goes—steady as Fed Chair Janet Yellen goes, that is. Her term expires in February.
Her successor, Jerome Powell, is similarly dovish, says Kronschnabel, so “this will be a pretty seamless transition.”
Waiting on opportunity
More interesting to Kronschnabel are potential U.S. tax reforms, which made some progress last week when they passed in the House. Proposed corporate tax cuts, for example, will benefit U.S. corporate issuers, he says.
Of more concern to the bond market are proposals to limit or remove interest expense deductibility, he says. If the proposals pass, corporate credit issuers would have less incentive to carry debt on their balance sheets, potentially resulting in fewer bonds being issued.
The result: “longer-term, upward pressure on prices, and lower pressure on spreads and yields,” says Kronschnabel.
Most affected would be highly leveraged companies with large interest expense. Such companies “tend to have less net income,” he says. “So the benefit they receive from a reduction in the tax rate would not necessarily help to offset the [loss of ] deductibility of their interest expense.”
If corporate bond spreads tightened significantly, Kronschnabel says, it would be “a structural change for the market.” It could also result in “significant gains to be had in corporate credit in the near to intermediate term.”