Buy & Maintain Credit Market Update

Webcast summary

The coronavirus outbreak and the response to it has shaken up investment-grade (IG) debt markets. The shock, however, is fading. Fiscal and monetary intervention has delivered a backstop for investors and allowed value opportunities to emerge from the gloom. It is a moment that we believe will reward deep credit analysis and a consistent, long-term investment approach.

Central banks and governments may not have moved in unison, and there were certainly delays, but when action did come it helped to soften the ripples from an early sell-off and has created an attractive entry point for selected names.

The initial sell-off was sharp. The speed of the moves was unprecedented – and reached spreads well above what we might normally expect in a recessionary environment. There were substantial outflows from credit funds, and ETFs traded at a massive discount. Energy is a big proportion of the market and was particularly badly hit.

Effective intervention

But when the Federal Reserve (Fed) moved, it went big. That prompted a substantial retracement in dollar-denominated IG markets, while in emerging markets and Europe spreads have remained wider. It is fair to note that spreads have not got close to the widest points seen in the 2008/2009 financial crisis, and that is owing to the sheer scale and pace of intervention.

One drawback of this interventionist approach – it is hard to sustain. Therefore, we would not be surprised by another move towards wider spreads in general. That could be prompted by a first wave of defaults. Ratings agencies have moved faster than the market had anticipated – faster than we have ever seen. That has meant a glut of ‘fallen angels’ moving from IG ratings into the high yield space and more will follow as sovereign downgrades impact the market. We also anticipate potential defaults in the IG space itself.

Trading dynamics

Central bank buying has certainly helped to bring liquidity back to credit markets and outflows appear to have slowed. However, trading remains a challenge, with BBB credits proving difficult to sell for some market participants.

On the other side of the coin, there has been something of a resurgence in primary issuance, which we see as the best way to allocate to credit right now. Deals here have sparked strong interest from a value perspective, prompting new investors to join the IG market. There has been a divergence between more active dollar issuance and that seen in sterling, where there is a demand/supply imbalance. We expect the sterling market will likely pick up in the coming weeks once earnings season is out of the way and when there is a clearer path to an exit from lockdown.

The upheaval has clearly delivered opportunities. March was a shock for IG markets and, by-and-large, spreads remain at very attractive levels – close to the 10th percentile in terms of value since the 1990s. We believe there are opportunities on a bond-by-bond basis as markets reopen and as a U-shaped recovery takes hold.

Finding value

It is crucial to remain selective and to embed diversification in that search for value. We have become more defensive and would tend to avoid emerging market names, as well as those from Italy, Portugal and Spain, and would prefer areas where support is the strongest – i.e. the US, Europe and the UK.

The thinking is similar on a sector level. We like national champions and industries most likely to find support from the continued policy responses. We will also seek out names best positioned to rebound strongly. We expect that sovereign and corporate downgrades will follow. However, we will resist being a forced seller, especially when our research indicates a company likely has the means to bridge the crisis and even thrive as the recovery emerges – an approach which should help us to access good opportunities. In addition, retaining flexibility in portfolios to opportunistically adapt our hedging and collateral management enables us to respond to client needs.

As ever, our focus will be on deep credit research designed to unearth quality companies that prosper over the long term – the crisis has only increased the importance of that approach. For pension schemes that can afford to de-risk, this moment represents an attractive level to lock in cashflows and returns for a longer period by implementing a Cashflow Driven Investing (CDI) approach. For insurance companies, credit is now a very attractive way to get yield. We believe the opportunities have increased for long-term investors, if the due diligence remains robust.

Another thing the crisis has made clear is the importance of communication between asset managers and their clients. We hope that we have delivered on this and will continue to do so.

Investment involves risk. The value of investments, and the income from them, can go down as well as up and an investor may get back less than the amount invested