From Apostle Funds Management portfolio manager Joe Unwin.
Why investors should favour credit over other asset classes in 2023
- Relative value in both defensive and risk allocations – better forward risk-adjusted returns in investment grade credit vs government bonds and high yield credit vs equities
- The credit universe is more diversified and allows managers to be dynamic across the yield curve and credit quality spectrum. This makes it attractive when the outlook is uncertain.
Investors should focus on these parts of the credit market
- Investors should take advantage of how diversified the credit universe is and be strategic with both duration and credit quality.
- For defensive exposures, investors should look at short-duration investment grade corporate bonds rather than treasuries. You’re getting an extra 1% in yield with almost no credit risk. The short end of the curve also has lower interest rate volatility and should experience greater price returns when the yield curve inversion corrects.
- For risk exposures, investors should focus on parts of the high yield market with low default risk. In BB corporate bonds, you’re getting a yield of 7% with little default risk. With equity valuations still above historical averages, the only way stocks can outperform this part of the high yield market is with significant earnings growth, which contradicts the economic outlook.
- For real income/inflation protection, the syndicated loan market offers floating rate coupon payments which provide great protection against inflation/rates. You’re currently getting a yield of almost 9% on loans relative to REITs offering a 4% dividend yield. For an option with lower credit risk, investment grade bonds are still offering an extra 1% yield over REITs.
If there is downside risk for the economy and corporate earnings, doesn’t that mean there should be a higher risk of credit defaults?
- Corporates will enter this downturn with relatively strong balance sheets which will lower default risk.
- However, to truly manage default risk, you need to be more active than that.
- Seek parts of the market that are essential and non-cyclical.
- Additionally, you can seek credit managers with strong track records of avoiding defaults.
How Apostle is using credit to enhance your portfolios this year
- In our diversified credit product, we are being dynamic with our allocations in the credit universe. We like short duration BB bonds which are offering about 7% yield with minimal default risk and low interest rate risk.
- We also focus on areas such as infrastructure credit that are essential and therefore have a default rate 75% lower than the broad market. You’re getting the same 8% yield here with much lower default risk.
