Authored by Jeff Boswell, Head of Developed Market Credit
27 March 2020
The views expressed in this communication are those of the contributors at the time of publication and do not necessarily reflect those of Ninety One as a whole.
Figures correct as per close of business 27 March 2020. All hedged to USD.
Where are we now?
During March, one of the fastest ever sell-offs pushed credit market valuations to levels normally seen in times of recession. However, it seems markets found a ‘floor’ – albeit possibly temporary in nature –before rebounding significantly over the course of last week.
Monetary policy action was a key catalyst for this positive shift in market sentiment. Specifically, the US Federal Reserve stepped up its support, with a number of measures having a direct positive impact on credit markets. The Fed relaunched its commercial paper financing facility – a policy tool that was used in 2008/9 – in a move that will help to alleviate companies’ short-term funding concerns. Separately, the Fed has begun buying US Corporate bonds directly in both the primary and secondary market; while this has been a well-trodden path by the European Central Bank since 2016, it’s a new measure for the Fed.
Together with the reopening of the primary market for US corporate bonds, a new 2 trillion dollar senate fiscal package has helped lift the overall mood of investors.
Here is a snapshot of key credit markets:
Source: Bank of America/Merrill Lynch, as at 27 March 2020. US dollars.
Where do we go from here?
Whether last week becomes the true floor in markets or we instead see a ‘double dip’ remains to be seen.
We believe the following factors would likely signal a floor:
- An improvement in important data (i.e. infection rates/mortality rates)
- Markets reach recession-like valuations
- Investor positioning moves from overweight to underweight
- Significant policy support is forthcoming
With the combination of substantial monetary and fiscal stimulus, the significant investor outflows and the substantial initial widening in spreads, it feels like we have come a long way on items two, three and four. However, we do not believe there is enough of a positive trend in the important data yet to call a floor; this remains the major concern and remaining vigilant and alert to changes will be important for investors.
What have we been doing in our unconstrained credit portfolios?
Portfolio changes over the last week are a continuation of the broad themes we have adopted over the last month.
We are investing in bottom-up opportunities that we estimate to have sold off too much relative to the quality of their fundamentals, and which we believe have the resilience to weather the current economic storm.
As spreads have moved meaningfully wider over the period, we have taken the opportunity to selectively add high-yield risk in our strategy, to seek to take advantage of the more attractive spread levels. As always, our bottom-up analysis is the driving force behind such moves. To allow us to make these investments, we have sold out of positions in areas of the credit market that have held up relatively well amid the recent market pressure.
Investment-grade debt is the segment of the global credit market that has seen particularly aggressive selling in recent weeks, as investors have sought to free up cash. We have increased our exposure to investment-grade debt, aiming to take advantage of the relatively high credit quality offered by select opportunities in this universe at particularly attractive valuations, given historically high spread levels.
We have also rotated our positioning within individual credit market sub-segments to seek to take advantage of investments offering similar credit quality but at better spread levels (i.e. offering better compensation for the level of risk taken).