James Blair, Capital Group
A number of investment professionals, including those at T Rowe Price, Citi Private Bank and Voya, have highlighted the opportunities in leveraged loans due to short duration and relatively high returns.
Blair, who joined Capital Group in January and was previously UBS Asset Management’s Asia-Pacific fixed income head, sees the asset class as resilient in a rising interest rate environment.
“Part of the reason for the hype of the leveraged loan market has nothing to do with relative valuations, ” he said. “It actually has to do with fearing the US Federal Reserve. The market has been concerned about US interest rate rises and the leveraged loan market is a floating rate market, and you don’t take much duration risk with leveraged loans.”
However, he believes that their popularity has made them less attractive compared to the corporate high yield market.
“We are not necessarily saying there aren’t opportunities in that market. We just think that the interest in the asset class has pushed spreads down to a level where they are not necessarily as attractive as the corporate high yield market in the US.”
Covenant lite?
Blair is also cautions about the quality of covenants in the leveraged loan market. Covenants are put in place in any debt agreement to protect lenders from borrowers defaulting on their obligations.
“Both the high yield and leveraged loan markets have seen a lightening up of covenants. But you probably see it even a little bit more in the leveraged loan market,” Blair said.
Moody’s Loan Covenant Quality Indicator (LCQI), which measures the strength of covenant protections in the leveraged loan market, hit its weakest yearly score in 2017, suggesting that leveraged loan investors face “significant future risks”, according to a report from the credit ratings agency.
Last year was the first in which overall covenant protections had an average covenant quality score higher than 4, the report added. The indicator uses a five-point scale, in which 1 denotes the strongest covenant protections and 5 the weakest.
“The long-term trend of diminished covenant protections continued through 2017, as investor demand for floating-rate instruments continued to outpace supply,” Enam Hoque, Moody’s vice president and senior covenant officer, said in the report.
“Against this backdrop, robust liquidity and a low default rate forecast have spurred refinancing activity, as borrowers opportunistically refinance and push out the maturity dates on their debt,” he said.
Opportunities in High Yield
Within the high yield market, Capital Group’s Blair sees more opportunities in the US market compared to Europe and emerging markets.
“We don’t see a lot of pricing and valuation opportunities in European high yield,” he said.
Turning to emerging markets, he said that it has had a tough period as they have been impacted by the strengthening of the US dollar.
However, he believes emerging markets have pockets of opportunities because valuations have become more attractive as investors have pulled some of their capital out of these markets.
“Generally, we see Asia is one of the shining lights in the emerging markets universe,” he said.
For example, Blair likes India’s local government bond market for its relatively low correlation to global investor changes in sentiment. However, he has less confidence in India’s currency outlook.
Capital Group Global High Income Opportunities vs global fixed income and high yield sectors
Note: Fund and sector NAVs have been converted to US dollars. Sectors are in the Singapore universe of authorised funds
The fund invests in emerging market government bonds and global high yield bonds and is co-managed by Robert Neithart and David Daigle,
