The war in Ukraine and a hawkish shift in monetary policy were the key drivers of credit market moves over the quarter.
The wide range of sanctions imposed on Russia (and Russia’s retaliation to these) caused significant uncertainty and disruption in financial markets, and the resultant soaring commodity and energy prices have put significant additional upward pressure on inflation. The US Federal Reserve raised interest rates and accompanied the move with decisively hawkish rhetoric, sparking a sell-off in rate markets which caused longer-duration investment-grade debt to be one of the worst performing credit asset classes in the quarter.
Widespread risk-off contagion following Russia’s invasion of Ukraine caused a widening of credit spreads, although much of that move was reversed with a solid rally into quarter-end as broader risk sentiment settled. Among high-yield issuers, the backdrop of rising commodity prices benefited bond prices in the energy sector, while higher inflation and rising interest rates weighed on issuers in the consumer products, food and real estate sectors. More broadly, amid the backdrop of credit spread widening, higher quality parts of the credit market have – somewhat unusually – underperformed, due to a combination of duration aversion in a rising rate environment and market technical dynamics, as we explain in this edition’s spotlight article. This has resulted in compelling valuations in some higher-quality market segments.
Leveraged loans showed impressive resilience, supported by short effective duration which offered protection from rates volatility, outperforming most asset classes. CLOs also performed relatively well through the market volatility. Similarly to leveraged loans, their floating rate nature also provided insulation from rising interest rates, explaining much of their outperformance compared to fixed rate products like corporate bonds.
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.
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.