Societe Generale

Societe Generale’s SA (EPA:GLE) (PINK:SCGLY) Dylan Grice believes that Quality Income equities are far more desirable than High Yield bonds. Societe Generale’s SA (EPA:GLE) (PINK:SCGLY) ‘s other strategist Andy Lapthorne has also expressed similar views, in fact Grice is only re emphasizing Lapthorne’s theory. Here is how he explains it:

The first thing that is stressed in the opinion is that, it is unwise and dangerous to draw a comparison between performance and returns especially in the case of high yield bonds and quality income, both of which have produced similar returns on Societe Generale SA (EPA:GLE) (PINK:SCGLY)’s high yield credit and QI index. The success of a strategy should be judged from the dynamics that produce those returns. Below is a graph that compares returns on both strategies through the years.

SGQI and High Yield Comparison

SG’s strategists rate high yield bonds as a junk investment and grades quality income as solid, reliable and robust. Grice agrees that the risks associated with Quality Income equities are far higher than other capital investments but rejects the assessment of risk as a valid comparison.

The argument is based on broadly three observations, the first being that any temporary loss in capital across different startegies is similar as is apparent when the highest drawdowns on equities are matched in the below chart:

SGQI and High Yield  drawdowns Comparison

The second observation details how the respective volatilities of each strategy lie in the same zone but at the same time considers that there is no equivalence to draw between price volatility and ?risk.

As both strategies lie close in terms of drawdowns and price volatitlty, the conventional inference would be that they would generate similar returns. But in case of Quality Income equities, the thing that is overlooked is that SGQI produces more profits for its investors as compared to ‘junk bonds’.

The performance of QI equities will shine even more when we consider that the past decade saw the largest credit inflation which sat well with high yield bonds but had no such effects on Quality income. The outperformance of QI under such cricumstances is even more impressive. Moreover nominal assets like bonds are more prone to the swings in inflation and this makes investment in Quality Income equities less risky. The graph shows how QI perform well irrespective of inflation and tracks long term dividend growth.

Grice is certain that Quality Income equities are well protected against any variations in inflation over the next deacde. QI are robust and are therefore a more attractive investment option by all comparisons. Grice quotes Lapthorne’s view on High yield bonds in the end,

“The recent junk bond rally has been fun. But like a 120mph motorway ride in an East
German Trabant, it’s taken its toll and you might want to switch into a Mercedes before the
engine explodes in a ball of flames. SG Quality Income is that Mercedes.”