Picture this: The misleading mean

The context

Through much of 2022, there was a notable lack of sector dispersion in global credit markets, with limited pricing differentiation between defensive and cyclical sectors. Jeff Boswell, Head of Alternative Credit, Ninety One: “As expected, the market has snapped back since then, with a combination of a flight to quality and mass retreat from riskier segments sending dispersion soaring.”

While the dispersion within credit markets is not unusual, it is the current extent of this that is remarkable. He illustrates this by considering the global high-yield market: as the chart shows, less than 21% of this market is trading at similar (within 100bps) spreads to the index average; a full 55% is trading tighter, with a tail (around 10% of the index) of stressed constituents pulling the headline index spread wider to reasonably attractive levels.

Boswell explains: “The upshot is that ‘the market’ is, in effect, a portfolio comprising a skewed barbell of underlying bonds – at one end trading very tight to the market and at the other very wide. Furthermore, the skew to the tightest trading (most expensive) bonds makes this portfolio particularly vulnerable to a market correction”.

While such high market dispersion poses problems for investors that are looking to ‘buy the index’, it is typically the ideal hunting ground for credit pickers – investors with the freedom to select assets where the risk-adjusted returns are the most attractive. Boswell continues: “Crucially, active credit pickers can also seek to avoid parts of the market that have become over-extended/expensive and particularly vulnerable to a correction. This is especially relevant against a backdrop of tightening liquidity and weakening global growth – conditions that will surely favour thoughtful portfolio construction in the coming months.”