Credit where it’s due


Today, global investment grade, high yield credit spreads are tighter than pre-Covid levels. Emerging market debt denominated in dollars seems better valued with spreads still higher than pre-Covid levels.

We see a major upgrade cycle underway in high yield credit, with more than four times as many upgrades than downgrades, a much higher ratio than at any time in the last. decade.

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Bonds remain expensive today, with returns across the spectrum of ratings following base rates lower. While underlying rates hit their lows last year (US 10-year rates fell to 0.5% in August 2020), they remain unattractive at current levels.

However, there remain areas of relative value within short-term high yield debt and emerging markets denominated in dollars, as well as floating rate credit.

Elsewhere, although there is a limited rise in further spread compression, the spreads are not extreme, and there is no clear reason, either from a valuation point of view or from a valuation point of view. fundamental view, so that spreads suddenly explode. As a result, we maintain significant allocations in the aforementioned value areas, as well as some prime credit.

For parts of the credit market to be cheap, spreads would need to be significantly above historical norms to offset the risk of rising underlying interest rates, and that is not what we are seeing today. .

Emerging market dollar debt appears to be the best value overall, with spreads of around 350 basis points. They were less than 300 for the entire period between June 2005 and March 2008, which we believe represents a level closer to fair value.

Credit fundamentals seem reasonable, however. A senior portfolio manager of a specialist credit manager recently noted the high ratio of ups and downs among high yield US issuers, combined with a falling default rate and a decrease in the volume of distressed debt, all of this combine to produce a strong fundamental backdrop for the asset class.

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Corporate debt is declining, while interest coverage is at manageable levels. The situation was helped by strong profits and low financing costs. Arguably this made it easier for investors to continue buying the downside, which supported stocks and credit spreads.

With over $ 300 billion in new issuance entering the U.S. high yield market this year, double what we’ve seen so far in 2019, and no increase in overall debt, it’s clear that companies take advantage of the low interest rate environment to refinance themselves and reduce their interest bills.

We spend most of our time analyzing fundamentals like these, as well as valuations, but it’s also important to keep an eye out for short-term signals and market dynamics. From a technical standpoint, while government bond yields have been increasingly less attractive in absolute terms, strained equity valuations have also been less attractive and have resulted in some forced bond purchases alongside central banks.

Moreover, the “war chest” of cash in money market funds that was built up at the start of the pandemic has barely been tapped, with plenty of cash available to mop up any new net bond issuance.

High yield markets in the US and Europe easily absorbed a record supply this year, indicating high interest in this debt, and spreads continued to trade within a narrow range despite the Fed’s decision to end. to its secondary market business credit facility.

We continue to appreciate the opportunities in certain segments of the credit market.

As a futures product (compared to stocks, which can be held in perpetuity), timing is more important when it comes to selecting credit, and we continue to see reasonable terms for our holdings today. ‘hui.

Richard Stutley is Portfolio Manager at Momentum Global Investment Management

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