Credit marches on as investors put money to work

Negative performance, fund outflows (redemptions), and increased levels of cash; in no particular order of significance, have been the major focal point for fixed income funds and portfolios for the greater part of 2018. All for different reasons. Some might argue that it came on the back of the end of the bond year rally, others believe that macro events such as the trade-wars, Brexit uncertainty, European political issues, and a global economic slowdown are all factors which could well explain investor uneasiness.

From a valuation perspective, there are also some who state that credit in general (all sub-asset classes within the fixed income space, from Investment Grade Corporates and Sovereigns, to High Yield and Emerging Markets) got way too expensive and the market sold off with the slightest negative news.

Let’s face it, we had stated on a number of occasions that heading into 2018, the downside risk to credit by far outweighed any capital upside potential. And all these factors could well be the case and are all plausible scenarios, outcomes, and thoughts of mind which ultimately, when concocted together and viewed within the context of the market conditions we were faced with last year, make the justification of last year’s market performance, even more acceptable to most.

To some, credit ended 2018 with some missing pieces to a complicated jigsaw puzzle, which, in all fairness, is a fair and correct assessment. However, despite the fact that 2018 was laden with uncertainty, the opportunities which were arising, through market weakness, particularly in the second half of 2018, were in fact parts of the missing pieces of the jigsaw puzzle.

Just as bakers and pastry chefs prey on our sweet tooth, asset managers and portfolio managers prey on bouts of volatility, market weakness and beaten down prizes, and are paid to do just that. Identify those companies and/or asset classes which are unjustifiably beaten down and use the cash available to them to pick up stock (be in the shape of bonds/equities) at cheaper levels. And whilst it might be a painful thing to do when volatility continues to prevail, sticking to their guns and focusing on conviction trade are traits and trades which will ultimately yield positive results, in terms of performance, capital appreciation as well as the creation of wealth.

January has been more than benevolent for markets, and credit markets have been no exception to that. Funds and portfolios are reaping the benefits of the painful (in the ultra-short term) conviction trades which portfolio managers took in the second half of 2018 (either by placing available in cash in beaten down securities, or even by not selling out of existing positions). In fact, those portfolios which, at times of heightened volatility were sitting on elevated levels of cash and out-performed the market on the downside, are now trailing the market when it rallies.

What we have seen so far is a resurgence of new issues on the European corporate bond market, and this flurry of new bond issues were well absorbed by the market given the excess levels of cash that asset managers were holdings onto, thereby pushing spreads even tighter. In addition, last week’s dovish tone by the ECB, whereby it was communicated that the first rate hike by the central bank has been pushed forward to possibly early 2020, saw a resurgence in the bid for credit.

With Brexit uncertainty prevailing, Italian government woes and the impact the US and China trade war having on the global economy still lingering on, we believe that, at least in the short term, the need for investors to put money to work following a lacklustre 2018 will persist for the time being as there still are some attractive valuations within the credit space.