Amid low interest rates, investors continue to look for sources of yield, and U.S.corporate bonds have garnered substantial interest. But in the late stages of an economic cycle and with very tight credit spreads over U.S. Treasuries, how should investors approach credit markets? We spoke with fixed income portfolio manager, Damien McCann, to get his take.
1. Given the current macroeconomic backdrop, how are you positioned in credit portfolios?
Economic data will remain a bit soft in the U.S. I don’t expect economic growth to accelerate to the levels that we were experiencing a year ago. That said, the recent softening seems more indicative of a leg down in the current cycle rather than the start of a recession. The Federal Reserve also maintains an accommodative stance, as we have seen with three interest rate cuts this year. Against this backdrop, I am not in a bunker in terms of how I’m building credit portfolios. Rather, it’s a modestly defensive positioning.
2. How do you plan to add value in these portfolios?
I may be oversimplifying this, but in a credit portfolio, one way to generate excess returns, or alpha, is to take a view on the direction of corporate bonds spreads and be a lot more or a lot less aggressive than the market benchmark. That is one lever available to investors, but it tends to result in periods of significant underperformance whenever aggregate credit spreads move against your view.
But there’s another, what we think is a more reliable approach, which is generating returns through security selection. That means picking the right corporate bonds that have their own idiosyncratic drivers, which means they move in price based on factors that are specific to those companies and not just the macro environment. My aim is to more consistently add alpha in most market environments by identifying companies where, working with our equity analyst counterparts, we see improving fundamentals or other catalysts for gains.
3. There is a lot of focus and market attention on corporate leverage. How does that factor into your thinking and approach?
There is no doubt that corporate debt and leverage have steadily increased since 2008. Loan covenants are less stringent in many cases, and there are signs of stress in some areas of the market. There’s also considerable concern about the growth of BBB bonds to $2.9 trillion, roughly quadruple the levels of 2008. That said, it’s important to not paint the entire market with one brush. As active managers, it’s our job to identify areas of opportunity. Our credit investment analysts talk to corporate executives regularly to identify companies with credible deleveraging plans and solid long-term strategies.