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Low default rates present opportunities in single-B credit
Short-duration strategies offer insulation from rising interest rates
Bayani S. Cruz 8 Dec 2021

Global high-yield credits performed very well this year in the midst of the pandemic and are likely to continue providing good investment opportunities despite the volatility and negative headlines expected to persist in 2022.

The reason is that relatively healthy single B-rated issuers have exhibited resilience during the pandemic as attested to by the very low default rates in the sector.

In addition, single-B credit can be a hedge against duration risk with its shorter maturities offering some protection against interest rate hikes that may come in 2022. The asset class also provides more secured credit at the lower end of the spectrum, which can be an insurance policy of sorts for investors.

“We certainly don’t see any spike in defaults arising as a result of the various issues that could come to pass mainly because we think governments will be relatively controlled, and companies are very well capitalized, and consumers generally speaking are in a pretty decent place, and they’ve got money to spend, and they will continue to spend it,” says Martin Horne, head of global public fixed income at Barings. The firm's  global fixed-income business has about US$225 billion in assets under management.

Stronger companies

Companies saw strong demand in 2021, compared with 2020 when waves of lockdowns completely disrupted the global economy, Horne tells The Asset in an interview.

This strong demand has translated into quick recovery and good performance for many companies, particularly those in the cyclical sector. However, on the negative side, this has aggravated supply-chain disruptions as companies struggled to produce enough products to meet the resurgence in demand.

The auto sector, for example, couldn’t produce enough to meet the strong demand because of the shortage in computer chips. “Now it’s a really odd situation for a cyclical sector because they can sell anything that they make right now, they just can’t make enough. Normally, when you’re worried about more cyclical-orientated industries, you’re worried about the downside of the demand curve. Here, demand is absolutely, rigidly high, it’s just that they can’t make enough of the product,” Horne says.

Moreover, single-B companies, in general, have issued record levels of debt in 2021 to beef up their capitalization and take advantage of the low interest rates with the expectation that this could change as central banks begin to raise their base rates again.

This has resulted in well-capitalized companies that are financially stronger despite the uncertainties arising from the pandemic. “These businesses are extremely well-capitalized, although there are lots of negative headlines around the world,” he says.

Thirdly, the pandemic is now at a different stage as the global vaccination efforts have been relatively successful, and this helps well-capitalized businesses position themselves better despite any further disruptions that may arise.

On the risk of rising inflation, Horne argues that the current inflation is rooted in supply-chain disruptions triggered by the pandemic. Unlike traditional inflation, this pandemic-induced inflation cannot be alleviated by central bank monetary policy.

“Inflation is a major risk but it’s a risk that the market is set to absorb. It’s not classic inflation in the way that it’s always been generated. It starts with supply-side dynamics and the supply-chain issues that are ongoing. Also, there’s a people supply-side issue. That means wages are rising in line. But if the end consumer is wealthier and can absorb the price rises, actually the risk should be manageable,” Horne says.

Opportunities

Investors can find opportunities in the high-yield sector, particular those based on Single-B credit assets.

“There are plenty of short-duration strategies around investment grade for those that want to stay up in the quality. That provides investors with insulation in a rising-interest-rate environment and those types of strategies are likely to see inflows as we manage the way through the headlines. Some of the inflation-resistant strategies are going to prove the most popular,” Horne says.

There are still opportunities in the Chinese property sector, despite renewed default fears over Evergrande. “At the height of the Evergrande concerns, some really good-quality Chinese property names are offering you about 1100bps, 1200 bps over [the benchmark], which is more than you got in Lehman’s,” Horne says.

Investors who are worried about interest rates can move to variable rate products such as loans, structured credit, and some mortgaged-backed securities which give a better coupon as interest rates rise.

 

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