At the start of this year, fixed-income investors’ unwavering focus on attractive yields continued to overshadow concerns over the other side of the credit-market coin (expensive valuations) – this drove credit spreads in traditional credit markets to multi-decade lows.
While credit spreads in these traditional markets have widened in recent weeks, it remains the case that investors with narrow horizons may be getting a poor reward for excessive risk. In contrast, investors with a broader credit-market lens can find plenty of opportunities to earn a decent spread (and for a lower level of credit risk) in more specialist areas such as the bank capital market.
Darpan Harar explains how a global, active, unconstrained lens is particularly relevant for fixed-income investors today:
“Now is the time to diversify away from the biggest, best-known markets and to take advantage of opportunities in specialist, alternative credit assets such as CLOs, hybrid securities, as well as bank debt,” he said.
By being unconstrained/untethered to any benchmark, Ninety One global credit income (GCI) has the flexibility to invest across markets and regions. This is especially helpful at a time when dispersion of credit market valuations is so high.
Fund manager Harar (pictured) takes a bottom-up view to rotate into the most attractive individual securities from the entire credit universe. In addition to finding the best value across the credit universe, his aim is also to achieve a smoother return profile compared with traditional credit strategies.
“Investors tend to be anchored to US credit given its market weighting, but up until very recently yield spreads were the most compressed for two decades,” said Harar.
The US investment grade sector has attracted substantial inflows over the past few years, making it one of the “most crowded fixed income market”.
Meanwhile, US high yield (or sub-investment grade) corporate bonds also entered the year at expensive levels. Whilst there has been a reasonable amount of repricing recently, the market is still pricing a default rate below long run averages. Careful credit selection is required here.
Instead, investors should take advantage of opportunities from a huge dispersion in spreads across credit markets.
Harar identifies higher returns and better risk characteristics from the “smaller cousin” in Europe.
Higher-rated bonds are cheaper on a relative basis than the US, while there is limited give up in yield among defensive sectors compared with cyclicals.
In addition, as an active, unconstrained manager, Ninety One can tap into specialist credit sectors which are neglected by more traditional investors.
These include CLOs, agency MBS and bank debt. Investment grade CLOs are yielding more than large parts of the US High Yield market.
“CLOs offer attractive risk-adjusted spreads. Although they have more structural complexity, investors are well compensated for these risks,” said Harar.
They offer more income yet have no extra impairment historically relative to similarly rated corporate debt, not least because they are well structured and backed by loans from a diverse range of sectors.
Finally, the banking sector is providing opportunities across the risk spectrum, noted Harar.
“Bank debt historically yields less than investment grade credit because it is safer and shorter duration, but since 2022 the sector has offered more income than the broader market,” said Harar.
Dynamic, unconstrained approaches can take advantage of this and all other anomalies in the fixed income market.
