By Jonas Wäingelin, NordicInvestor
Global markets are facing unprecedented challenges in confronting the COVID-19 health crisis. Policymakers are responding with dramatic monetary and fiscal actions to bolster industries, businesses and individuals. Uncertainty is high and the recovery could be slow and bumpy. Amid extreme volatility, corporate market dislocations are creating potentially attractive investment opportunities. In these circumstances, a dynamic, flexible approach to credit investing is especially important.
Wellingtons’ Multi-Sector Credit approach focuses on higher-yielding sectors across the credit spectrum to generate income and total return from a more diversified universe.
The investment decision-making process integrates top-down analysis of global investment themes, rigorous fundamental economic and quantitative analysis and specialist research on individual credit sectors with bottom-up security selection.
Campe Goodman is the lead portfolio manager. He is supported by the firm’s global research platform, which integrates specialist economic, credit, currency, equity and commodity analysis, providing comprehensive research on sectors, countries and individual securities across the capital structure.
In this Q&A he shares his views on the credit markets, the impact of Covid-19 and how he is allocating capital across sectors.
What is your default outlook for corporate, asset backed, and emerging market debt at the broad asset class and sub-sector levels? How does this compare with previous cycles such as 2008?
We anticipate that high-yield defaults will increase in the coming 12 months toward past recessionary levels. We expect many of these defaults to occur in commodity-sensitive sectors (energy, metals and mining), as well as retail. While we acknowledge the challenging market environment, we believe high-yield spreads more than compensate investors for forward-looking credit losses. As a result, investors with a longer-term time horizon (three years or more) may find good value in high yield, in our view. We are looking for opportunities to add risk where we observe extreme price dislocations.
Consumer balance sheets were strong coming into this crisis. Low interest rates and oil prices are beneficial, but rising unemployment will create stress, especially for low-income consumers. We are worried about a virus-driven decline in consumer confidence and reduced ability to pay debts, particularly among subprime consumers. However, we expect that various monetary and fiscal stimulus measures – including loan modifications, extensions and forbearance across mortgage and consumer loans – should help mitigate a sharp increase in defaults within consumer ABS sectors and, in particular, senior tranches of short-duration paper.
Most emerging markets (EM) countries entered the crisis with reasonably sound fundamentals – modest growth, low inflation, manageable fiscal deficits, and healthy balance of payments and liquidity positions. All EM countries will suffer from this shock, requiring a reassessment of fiscal, external, and monetary policy flexibility to navigate it. Those with fewer policy tools will see a higher risk of default priced into valuations and may experience more downside risk over the near term. We are evaluating the issuers most exposed to the virus via the transmission channels of tourism, commodities, supply chain disruptions, and governance. Similarly, on the oil front, we are looking to identify issuers (both sovereign and non-sovereign) that can either sustain a prolonged period of sharply lower oil prices or stand to benefit from current dynamics.
Which of your sectors (global high yield, bank loans, emerging market debt (sovereign, corporate, local), structured finance (RMBS, CMBS, ABS), securitized debt, investment grade credit and convertible bonds), rates and inflation currently offer the most attractive risk adjusted returns? Which are you overweight of and underweight of? Are you avoiding any sectors altogether?
We favour assets with some of the highest spreads among their respective risk categories, including global high yield, US bank loans and parts of the structured finance universe (non-agency RMBS, and certain areas of CMBS and ABS). We also find value in convertible bonds, which we view as an opportunity to gain exposure to issuers with strong upside potential in high-growth areas of the market, notably biotechnology. We are not currently making a strong directional call on rates or curve shape, but we expect that US rates could stay low for some time.
Some asset managers have publicly said they are tilting their asset allocation towards those sectors that central banks will buy. Do you agree?
Not necessarily. We previously held allocations to sectors that we thought would recover quickly because of aggressive central bank purchases. However, the efficacy of these programmes has led spreads in many asset classes eligible for central bank purchases to compress rapidly – though some remain well wide of their historical averages. For example, IG credit curves have steepened, and we no longer find value at the front end of the credit curve, while longer-dated IG corporates offer low yields and long durations. In fact, we currently find that the most attractive risk-adjusted returns are in some of the asset classes not eligible for central bank purchases, such as bank loans, high-yield corporates (excepting certain fallen angels) and non-agency RMBS. However, we still hold agency MBS for their diversification benefits, and we continue to find value in short-dated amortising consumer ABS deals which are eligible for the TALF programme. Select EM central banks have embarked on quantitative easing, though the scale pales relative to developed markets and spreads generally remain wide to fair value, in our view. We are focusing our exposures on countries that are better able to cope with the economic and health care impact of COVID-19. We continue to find particular value in EM corporates, where extreme dislocations persist.
In the current climate, how much value do you expect to add through sector selection and how much through security selection within sectors? Has this changed over the past year?
In this environment, we are continuing to find opportunities to position around both sector- and security-level dislocations. We have witnessed high degrees of dispersion across sectors in the current climate of global recession and elevated volatility. This creates opportunities to actively rotate in and out of sectors, and potentially exploit market dislocations. The spread environment, along with signals from our mosaic of cycle indicators, led us to increase our credit beta during March and adjust our sector exposures based on relative value. Our sector specialists have made security selection decisions by looking for businesses which they believe are fundamentally healthy over the long term and have ample liquidity in the near term. We believe that a broad, specialist-driven fundamental research platform can consistently identify underappreciated investment opportunities arising from these inefficiencies, which are rife in the current climate.
Are you holding some cash either for “dry powder” to take advantage of any further sell-offs, or to make it easier to pay any redemptions?
Yes. We remain enthusiastic about adding credit risk, as valuations have not fully recovered despite the extraordinary monetary and fiscal stimulus measures, and given greater visibility into the likely trajectory of COVID-19 in developed markets. We have also been raising cash by allowing positions in cash equivalents and short duration instruments to roll off. This barbelled approach to adding risk while also improving liquidity stems from our recognition that the current environment is both volatile and full of opportunities.
