Credit investors will be picky about what they buy in Europe’s expensive debt markets next year.
Amundi SA, Newton Investment Management Ltd and Western Asset Management are digging into companies’ balance sheets, analyzing how they make money, measuring profit margins and weighing how well they can cope with rising interest rates and slowing growth. global. And that’s on top of stretched valuations, the prospect of fewer central bank asset purchases, and a new strain of coronavirus that the market knows little about.
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“Investors will need to select more stocks,” said Gregoire Pesques, global credit director at Amundi, Europe’s largest asset manager. “There is less overall value in the market as a whole. But it is also because the specific risk will increase, so you will be more rewarded if you spend more time selecting the name. ”
It’s a change from the past two years, where virtually every corner of credit recovered after central banks and governments stepped in to provide unprecedented support during the pandemic. But the vast stimulus unleashed to support economies after periodic shutdowns has fueled rampant inflation. And the prospect of higher interest rates will raise borrowing costs, albeit from record lows.
“There will be divergence within credit and within geographic regions,” said Paul Brain, director of fixed income at Newton Investment Management. “Credit analysts are really earning their salaries now.”
One area where credit may differ is capital spending, which is booming as companies plunge into the war chests they amassed earlier in the pandemic, according to Bank of America strategists, led by Barnaby Martin. .
In a research note dated Nov. 12, strategists recommended buying the debt of high-spending companies in areas that promise high-quality, sustainable top-line growth. Transportation, technology and retail are among the sectors with the highest year-on-year growth in capex, according to their analysis. But the same industries are also grappling with supply chain bottlenecks, underscoring the need to be selective.
Another is trading, which can have mixed results for bondholders, according to Annabel Rudebeck, director of non-US credit at Western Asset Management. One example: the bonds of Telecom Italia SpA and British retailer Marks & Spencer Group Plc fell last month due to reports of private equity acquisitions, as this can burden companies with more debt.
Until recently, the great stimulus of the pandemic era has served as a lifeline for weaker companies. An extension of that support, should the pandemic enter a dangerous new chapter, could fuel another broad-based rally, making stock selection less vital. But central bankers are in a difficult position.
Even with a new strain of virus spreading globally, Federal Reserve Chairman Jerome Powell said last week that asset purchases could end earlier than planned given ongoing inflation. And if central banks ease monetary stimulus, companies that have weathered price pressures so far may start to see their margins sink in 2022.
“Jump into the middle of next year, you will have a tightening of monetary conditions at a time of higher costs,” said Brain of Newton Investment, adding that one of the gaps that can be opened is between CCC-rated bonds, the lower notch of junk and BB-rated bonds if default rates start to rise.
“Credit markets can start to have a serious wobble at that point.”
‘Smart and short’
But backing the right companies isn’t enough: Investors will also need to look for the right debt structures, said Gina Germano, director of high-yield bonds and syndicated loan investments at Hayfin Capital Management.
Concerns about inflation and the tightening of the central bank make floating-rate instruments, such as leveraged loans and guaranteed credit obligations, attractive, he said.
Investors can also significantly reduce duration risk by choosing notes that benefit more from roll-down, the natural compression of the spread that occurs as bonds near maturity, said TwentyFour Asset Management portfolio manager Pierre Beniguel. Three- to five-year bonds will tend to deliver the best returns as the short end of the curve steepens, provided they provide sufficient headroom to absorb anticipated rate hikes.
The bottom line is that “2021 hasn’t exactly been the hardest year to be a credit analyst,” Beniguel said. “Credit exposure should be smart and short in 2022.”
© 2021 Bloomberg