Part I: Current Market Pricing and Opportunities
We currently consider the rewards for owning credit to be thin as credit spreads and yields are at, or close to, record lows. This can be seen by Figures 1 and 2 to the right.
However, we believe some areas still offer attractive LONG opportunities such as:
• Short duration High Yield credits
• COVID “re-opening” plays
• Strong COVID performing credits
• Positive Event Opportunities: Re-financings of short calls, legacy financials (Liability Management Exercises) & IPOs/M&A (i.e. winners picking off the losers)
• Primary Market: Attractively-priced new issues that we would consider as strong core long positions
• Equity-linked Ideas: Convertibles near their bond floors (i.e. owning the call option with limited downside); re-org equity where the positive credit story changes into more of an equity-related story
Source: ICE Indices, US High Yield refers to the ICE BofA US High Yield Index Ticker: H0A0 as of 11 February 2021.
Figure 1. US High Yield Yield-to-Worst (%)
Figure 2. US High Yield Spreads (bps)
Part II: As Credit Markets Face Twin Threats
We also believe that the risks of owning credit may be high, if economies:
• Rebound too strongly (with rising inflationary expectations as emphasized by Figure 3). If this were to occur we could see a mass exit from fixed income markets as the risk-free rate rises.
• Fail to develop sufficient momentum, which would likely lead to spread widening as default expectations increase (refer to Figure 4).
Consequently, given these risks we expect rising market volatility and spread dispersion in credit markets, looking out over the next 12 – 18 months.
Figure 3. Rising inflation expectations & commodity prices1
Figure 4. Increasing leverage in High Yield, while credit spreads move lower2
So, what would we consider for the SHORT side of our balance sheet?
• Fundamentally weak businesses that are overpriced/will require restructuring (regardless of COVID)
• Credits perceived to have manageable COVID-related risk but we believe that optimism to be misplaced
• Credits that are likely to struggle to refinance as debt maturities shorten
• Names/sectors where we identify downside asymmetry (negative convexity) in combination with anticipated deteriorating future performance
What are some potential portfolio exposures we might consider hedging?
• Interest Rate Risk (through Government bonds, futures and bond options)
• Market Beta Risk (through credit indices: CDX & iTraxx, credit swaptions, out-the-money equity puts, ETFs and IBOXX indices)
Source: Bloomberg Finance L.P, US 10-Year Breakeven: USGGBE10 Index; Commodity prices refer to the Bloomberg Commodity Index (BCOM), as of 18 February 2021.
Source: ZeroHedge, ICE Indices. US High Yield refers to the ICE BofA US High Yield Index Ticker: H0A0 as of 11 February 2021.
All information and opinions contained in these articles represent the judgment of Simon Thorp at the time of publication and are subject to change without notice. The views expressed are those of the Portfolio Manager but may not be the views of Aperture Investors UK, Ltd and its parent company Aperture Investors, LLC (“Aperture”). For more information about costs, risks and conditions in relation to an investment or a service, please always read the relevant legal documents.