Capital Ideas^TM

Portfolio manager Damien McCann explains where he sees value across four primary credit sectors. 

 

Video transcript

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Damien McCann

Hi, I'm Damien McCann. I am the Principal Investment Officer for our multi-sector income strategy.

In our multi-sector income strategy, we invest across four primary credit sectors: the US high-yield market, the US investment-grade corporate market, emerging market debt, dollar denominated, and securitized credit. I'm being asked by clients and investors where I'm seeing value across these four primary credit sectors.

As we look at credit spreads, generally we don't think we're being particularly well compensated. This leads me in a multi-sector context to prefer the higher quality sectors. So that would be investment-grade corporates and securitized credit where we have overweights to both of those sectors. And then we're underweight the higher yielding but lower quality sectors. So let me now speak a little bit about each of those sectors. We are seeing more value in investment-grade corporates. Spreads are wider than they were a year ago. And while on a longer term historic basis, spreads are not especially wide today, we do think that there would be significantly less spread widening in investment-grade corporates in the event of a big slowdown in growth or a mild recession compared to other credit sectors.

We're also seeing very strong demand for all new issues in investment-grade corporates from a wide variety of investors who are coming into the market in size as they attempt to lock in these much higher yields for a longer period of time. And investment-grade corporates, we typically have access to companies borrowing either on a five year term, a 10-year term, 30-year term, or sometimes even 40 year.

In securitized credit, we're finding value in subprime auto, and we're focused on the higher rated tranches within these structures where we think we're getting well paid in the context of a consumer that is very resilient and fully employed, as well as used car prices, which are quite elevated compared to history.

In the high-yield market, we're also investing pretty conservatively at the moment, preferring to focus on companies that have resilient earnings and free cash flow.

Even in a weaker economic environment, rates are significantly higher than they were just one year ago, and any company, irrespective of credit rating will face significantly higher borrowing costs as they come to market. And so it's important as our analysts look across the landscape, that we identify companies that can accommodate significantly higher coupons on incremental debt issues without causing any stress to the balance sheet. In emerging market debt, we see more value in the higher yielding, lower rated issuers, sovereign issuers, than we do in the higher quality issuers. And that's primarily just because of a significant difference in valuation where spreads are just very wide across high-yield rated EM. And our analysts are finding value. In particular, we're focused on Latin American issuers where central banks in many Latin American countries were even more proactive than the US Fed in hiking rates to try to get ahead of inflation. And we're seeing more significant improvements in inflation in these emerging markets than we are in developed markets. And we think we're being paid well for this situation.

So as painful as 2022 was, significantly negative total returns for fixed income investors as yields increased from starting very low levels in early '22 increased dramatically over the course of the year, the silver lining is that the yield opportunity is now better for fixed income investors. And so as we look out over the next several years, the probability of a negative total return is actually pretty low because starting yields are now so high. So, we view now as an excellent time for fixed income investors to come back into the market.