On 29 September GAM Investments hosted a fixed income panel titled ‘Credit where credit is due’. With spreads and underlying yield curves pricing near or at historic lows, has the asset class run its course? Casey Goldmann, Richard Briggs and Tom Mansley discussed whether there are still overlooked pockets of value that could potentially offer attractive returns and portfolio diversification benefits.
Casey Goldmann - Global Corporate High Yield
Year to date, global high yield (HY) has outperformed other fixed income classes. This has been due to economic growth associated with the ‘reopening’ theme, sharply declining default rates / implied default risk and lower-interest-rate sensitivity. While we see little value left across the Western investment grade universe, at today’s record-low levels, and in turn high interest-rate sensitivity, the higher-quality HY space in the US appears attractive. This is particularly the case when looking at BB- versus BBB-rated spread differentials that have room for compression at a time of strong economic growth, healthy corporate balance sheets from liquidity raised in 2020, as well as the continuing trend of rating agency upgrades. This includes rising stars that should further outpace falling angels. There may also be areas of value in single B-rated credits – which we believe the agencies have been slow to upgrade despite the better-than-expected operating performance, cash flow and debt repayment.
Of late, we are cautious on the CCC-rated segment as valuations are tight and over the longer term, CCCs have much lower Sharpe ratios with unexpected events having a bigger impact on returns. Underweights in the energy space appear attractive with spreads tightening considerably and, therefore, less compelling in a historically volatile sector. European corporate credit also looks very stretched. In emerging market (EM) corporates, spreads are currently wide compared to US HY, with a relationship almost the widest it has been in for the last 10 years. Opportunities and risk vary across different regions and sectors but the average wider spreads could offer areas of value.
Richard Briggs - Emerging Markets Hard Currency Debt
In the sovereign credit space, EMs are today particularly low priced on a relative basis compared to the rest of the fixed income universe. Against developed market corporate debt, credit spreads on US dollar sovereign debt are very wide and are still significantly above pre-Covid-19 levels. On top of this, fundamentals are generally supportive and a global growth rebound also typically leads to tighter spreads. In addition, less than 5% of the headline hard currency sovereign benchmark index, JP Morgan EMBI Global Diversified, is allocated towards Chinese issuers – all of which are either sovereign or fully sovereign owned quasi-sovereigns – meaning limited linkages to Chinese property. Bottom-up, credits we view as offering particularly compelling value include Egypt, Ecuador, Ukraine and Pakistan, which should be able to gradually improve in the current environment and are less vulnerable to a crisis in the medium term. Within distressed EMs, Zambia and Tunisia look attractive. In turn, we are staying clear of Sri Lanka, Ethiopia, Turkey, Mozambique and most notably El Salvador, where we view the risks as not being compensated for despite high yields.
Chart 1: Chart 1: Average total returns of three top and bottom performing countries in the JPMorgan EMBI Global Diversified Index in 2021
Tom Mansley - Asset- and Mortgage-Backed Securities
Generally, publicly-traded structured debt outside the US has become rather expensive. However, we still see good value in the US non-agency mortgage-backed security paper, a market which did not benefit from direct government or Federal Reserve quantitative easing support during the Covid-19 crisis. In particular, the legacy non-agency mortgage market is still trading at spreads wider than pre-Covid-19, and given the strength of fundamentals and market technicals, should tighten beyond those levels. As it continues to recover and catch up with other sectors, this could provide an opportunity for capital gains if the spreads continue to converge to those of other asset classes that have fully recovered. Fundamentally, the US housing market continues to be one of the bright spots of the economy. The demand for houses continues to outweigh supply, leading to solid price appreciation, and we expect house prices to be well supported for the foreseeable future, even more so in an inflationary environment. US consumer credit balance sheets are the strongest they have been in decades. The debt to income level has been decreasing for the last 13 years and is now at levels that were in place 20 years ago. Furthermore, when the low debt levels are combined with locked-in low interest rates, the proportion of disposable income that is required to pay interest on the debt is at record low levels. This makes it easier for US borrowers to pay their debt, in our view.
The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development.