By Thomas Samson and Hugo Squire, Muzinich & Co
As volatility rises and the beta rally draws to a close, how can investors strike a balance between return maximisation and drawdown protection?
In our view, the fundamental backdrop in European high yield remains strong and investors should continue to benefit from the attractive carry available. The high yield market is less levered, better rated and has greater interest coverage ratios on average than at any time in the past several years.
Having said that, 2018 is turning into a year of transition as the market begins to contemplate life after European Central Bank (ECB) quantitative easing (QE). Rising rates, plateauing or rising credit spreads and increased volatility are returning to credit markets.
We believe that, in this context, active management and stock picking will once again come to the fore and managers will need the full suite of investment tools at their disposal to transition smoothly into a new regime.
Extraordinary central bank measures have had a profound effect on risk assets over the last two years. From our observations in the credit market, spread dispersion was all but erased and bottom-up credit selection was not necessarily rewarded.
As we begin the slow process of withdrawal from these extraordinary measures, we believe it is inevitable that dispersion rises from historically low levels and credit selection becomes a meaningful differentiating factor. Identifying the good credits from the bad will once again drive returns.
Fig. 1 – Spread Dispersion Rising from Lows