Global Credit | Q&A with Darpan Harar
0:00
0:00
Q What drove market performance in 2024?
Most credit markets delivered robust returns in 2024. While healthy fundamentals and benign default rates certainly helped, the dominant driver was an unprecedented wave of demand for fixed income, particularly in traditional credit markets. Lured by historically high levels of income – which surpassed the earnings yield offered by most major equity markets – investors piled into the asset class.
Q Where has that left credit markets today?
Investors’ unflinching focus on attractive yields – overshadowing any niggling concerns about the other side of the credit-market coin (expensive valuations) – ultimately drove spreads in traditional credit markets to multi-decade lows. That has left some of the biggest and best-known markets vulnerable to a potential correction in valuations. Take the US high-yield market: although the underlying quality of this US$1.3 trillion market has improved over recent years, meagre current credit spreads really don’t seem sufficient to compensate investors for the default risk they face in this market.
Q Which parts of the market look the most Interesting?
Across the broader global credit investment universe, there is currently huge dispersion – with a significant disconnect between valuations and quality in some market segments. This is creating an opportunity for investors to add assets that offer high levels of income without sacrificing credit quality.
Considering again the (now very expensive) US high-yield market, other areas of the credit market can provide the same level of income but at much lower risk (i.e., higher credit quality). Bargains on offer in today’s credit market include low-risk tranches of some collaterlised loan obligations (CLOs are bonds that are backed by pools of typically sub-investment grade corporate loans) that pay more income than the majority of the (much riskier) US high-yield market.
Other specialist parts of the credit markets that look particularly interesting include agency mortgage-backed securities (MBS are securities issued by US government-sponsored organisations such as Freddie Mac or Fannie Mae). Offering compelling value relative to investment-grade corporate debt and even parts of the high-yield market, this is also one of the few areas where credit spreads are wide relative to history (i.e., valuations are historically attractive), driven by weak demand/supply dynamics and elevated uncertainty around interest rates – factors we expect to normalise. Elsewhere, leveraged loans look compelling, and the AT1 (bank capital) market – which returned 12.2% in 2024 – still offers pockets of value, but selectivity within this market is key.
Q How do different regional markets compare?
While valuations in the giant US credit markets look very stretched overall, the same cannot be said for Europe’s investment-grade debt market, which still pays investors higher spreads than in 2021.
This regional (US/Europe) divergence can be seen across credit markets – in both traditional and more specialist areas. Although this partly reflects the weaker economic outlook in Europe, we think demand behaviour has dominated market moves, resulting in a compelling risk-adjusted return outlook for some of these European assets.
Q What can investors do to mitigate tariff-related risks?
Under Trump’s second term, the potential impact of tariffs on Europe’s manufacturing-centric economies is a concern for investors. Fortunately, today’s credit markets offer investors the chance to favour the more defensive sectors without sacrificing much income. For instance, investors can earn a similar income from corporate bonds in the utilities sector – which benefits from a domestic focus, defensive nature and relative immunity to tariff risks – to what they get from more cyclical sectors.
Other parts of the corporate bond market that look attractive and are relatively immune to Trump 2.0 include the European banking sector. Even though this performed very well in 2024, strong company fundamentals and the potential to benefit from any steepening of the yield curve creates a positive outlook.
Q How can investors get the most out of credit markets in 2025?
Investors with the flexibility to explore all areas of the broad global credit market opportunity set are best placed to take advantage of current market conditions, which offer a rare opportunity to boost portfolio resilience at low opportunity cost. Related to this, a dynamic approach to asset allocation will allow credit investors to shift towards the most attractive segments as conditions evolve.
In addition, significant dispersion in valuations – both across and within market segments – makes a bottom-up approach to investment selection particularly important today.
General risks. No representation is being made that any investment will or is likely to achieve profits or losses similar to those achieved in the past, or that significant losses will be avoided. Individual companies or securities named in this material are included for illustrative purposes only. The views expressed are those of the contributor and do not necessarily represent Ninety One’s house view. The information should not be seen as a forecast of how such securities will perform and should not be construed as investment advice or a recommendation. All investments carry the risk of capital loss. The value of investments, and any income generated from them, can fall as well as rise and will be affected by changes in interest rates, currency fluctuations, general market conditions and other political, social and economic developments, as well as by specific matters relating to the assets in which the investment strategy invests. If any currency differs from the investor’s home currency, returns may increase or decrease as a result of currency fluctuations. Past performance is not a reliable indicator of future results. Environmental, social or governance related risk events or factors, if they occur, could cause a negative impact on the value of investments.
Specific risks. Default: There is a risk that the issuers of fixed income investments (e.g. bonds) may not be able to meet interest payments nor repay the money they have borrowed. The worse the credit quality of the issuer, the greater the risk of default and therefore investment loss. Derivatives: The use of derivatives may increase overall risk by magnifying the effect of both gains and losses leading to large changes in value and potentially large financial loss. A counterparty to a derivative transaction may fail to meet its obligations which may also lead to a financial loss. Interest rate: The value of fixed income investments (e.g. bonds) tends to decrease when interest rates rise. Liquidity: There may be insufficient buyers or sellers of particular investments giving rise to delays in trading and being able to make settlements, and/or large fluctuations in value. This may lead to larger financial losses than might be anticipated. Loans: The specific collateral used to secure a loan may decline in value or become illiquid, which would adversely affect the loan’s value. Many loans are not actively traded, which may impair the ability of the Portfolio to realise full value in the event of the need to liquidate such assets.
Authored by
2025 Outlook
