Credit

Credit Chronicle: Q3 2022

Ninety One’s credit team reflects on the blanket sell-off in credit markets this year and how investors should expect greater dispersion in the next phase. The team also summarises recent developments across the credit investment universe.

20 Oct 2022

15 minutes

DM Credit Team
Ninety One’s credit team reflects on the blanket sell-off in credit markets this year and how investors should expect greater dispersion in the next phase. The team also summarises recent developments across the credit investment universe.
It was a quarter of two halves, with credit markets particularly strong in July due to a shift in investor perception towards the view that central banks will slow their pace of rate hikes. However, following the hawkish comments from the Fed at Jackson Hole, we saw a material deterioration in sentiment for credit markets.

Pressure remained on credit markets in the third quarter, with a continuation of the global macro themes evident earlier in the year. Persistent inflation and a strong labour market have led global central banks to continuously hike interest rates, intensifying recessionary fears once again. On top of this is an energy crisis in Europe, which is putting pressure on consumer and global food prices. That said, simply analysing the quarter’s start and end points hides its rollercoaster nature: credit markets were particularly strong in July and the first half of August – reflecting a bear-market rally; this shifted completely in the second half of August and into September. Driving the initial rally was a shift in investor perception towards the view that central banks will slow their pace of rate hikes and not take monetary policy into overly restrictive territory. This notion was finally put to rest at the annual Jackson Hole central bankers’ summit, where Fed Chair Jerome Powell stated that “restoring price stability will likely require maintaining a restrictive policy stance for some time.”

In the weeks following Jackson Hole, we saw a material deterioration in sentiment for credit markets, which ended the quarter in broadly negative territory. Both high-yield and investment-grade market segments posted negative quarterly returns, although investment grade underperformed given the sharp rise in US Treasury yields. In contrast, loan markets ended the quarter in positive territory – benefiting from their floating-rate nature – however, they gave up most of their earlier gains in the second part of the quarter on similar fears to those outlined above.

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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.

General risks

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.

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DM Credit Team

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