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For fixed income investors, varying the amount of credit risk in your portfolio can exert a major influence on the portfolio’s realized alpha. Indeed, historical data shows that this single factor can have a larger impact than decisions around what bond sectors or individual issuers to invest in. Accordingly, it’s worth spending some time thinking about precisely how much credit risk to take and when. My latest research in this area focuses on the role that valuation can play in adjusting credit risk over an economic cycle.

Methodology at a glance

I looked at the strategic timing of buying and selling credit exposure (in the form of corporate bonds, using cash or US Treasuries as a funding source) with low turnover, and using market valuation as the sole buy/sell signal. There are, of course, other predictive drivers of credit returns, such as…

MACRO
MARKETS
Robert Burn
Rob Burn
CFA
Fixed Income Portfolio Manager
Boston

With global high-yield spreads still quite tight as of this writing, we continue to suggest that investors pursue a slightly defensive risk posture and focus on individual security selection. At the same time, investors should maintain flexibility to position nimbly and opportunistically in response to changing market conditions — because we expect greater frequency of short-term market sell-offs going forward.

Macro environment: Positive

  • In the near term, we have a more favorable view of the prevailing macroeconomic tailwinds than we did in the fourth quarter of 2020.
  • Medium to longer term, we have growing concerns around the risk of US Federal Reserve (Fed) “tapering” rhetoric and its potential impact on risk assets.
  • Accommodative fiscal policy has helped bolster corporate balance sheets, which is an unusual characteristic of a post-recession economic recovery.
  • Increased money supply and stockpiled savings could be…

 

MARKETS
Christopher Jones
CFA
Fixed Income Portfolio Manager
Boston
Michael Hong headshot
Michael Hong
CFA
Fixed Income Portfolio Manager
Boston
Konstantin Leidman headshot
Konstantin Leidman
CFA
Fixed Income Portfolio Manager
London
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In my August 2020 blog post, I highlighted a potentially compelling return opportunity in the often-scorned universe of “fallen angels” — formerly investment-grade-rated corporate bonds whose ratings have been downgraded to high-yield (i.e., below-investment-grade) status by major credit rating agencies. I noted that, within two years of being thus downgraded, fallen angels as a group have handily outperformed the broader US high-yield index (and all three of its quality subgroups) over the long term.

Fast forward to early 2021: What I call the “fallen-angel effect” appears to have lost none of its luster. And notably, my latest research revealed that it’s not limited to just…

MARKETS

ARCHIVED

Robert Burn
Rob Burn
CFA
Fixed Income Portfolio Manager
Boston

Near term, our view on the high-yield market remains that a neutral-to-slightly cautious risk posture, with a heavy focus on security selection, is warranted amid spiking COVID numbers, the US political transition, the waning effects of government stimulus, and credit spreads having tightened from earlier this year. Longer term, however, our outlook is more positive as we see plenty of reasons to be optimistic as we look out nine to 12 months from now.

Macro: Strong medium-to-longer term

  • We anticipate a difficult short term marked by increased credit stress over the next couple of months, along with a possible reacceleration in high-yield defaults, followed by a much more supportive medium-to-longer term.
  • We expect the global economic backdrop to rebound strongly in 2021 and into 2022, particularly as COVID vaccines become reality and if governments deliver additional stimulus.
  • European economies could begin to show improvement as early as the first quarter of 2021, while the US economy is likely to strengthen in earnest starting in the second half of the year.
  • One big question for high-yield investors right now is: Will the market engage with the near-term downside risks or look through to…
MARKETS

ARCHIVED

Christopher Jones
CFA
Fixed Income Portfolio Manager
Boston
Michael Hong headshot
Michael Hong
CFA
Fixed Income Portfolio Manager
Boston
Konstantin Leidman headshot
Konstantin Leidman
CFA
Fixed Income Portfolio Manager
London

Factor investing – tilting a portfolio toward securities that have certain attributes (e.g., attractive value, quality, momentum, etc.) – has become widely accepted and practiced in the world of equities. Within fixed income, it is in a more nascent stage.

However, we believe that applying a factor-based investing framework can lead to valuable insights into what is driving performance in different sectors of the bond market. Even more important, it may allow investors to better position their portfolios to take advantage of…

MARKETS
THEMES

ARCHIVED

Samuel Steere
CFA
Investment Director
Boston
Brendan Fludder
CFA
Research Manager
Boston

The term “fallen angels” has always carried a somewhat pejorative connotation among fixed income investors. In some instances, that may well be justified, but not always. Indeed, particularly in today’s environment, I believe discerning investors may be able to uncover attractive value in the often-scorned universe of fallen angels.

Lay of the land

  • Fallen angels are formerly investment-grade-rated corporate bonds whose ratings have been downgraded to high yield (i.e., below investment grade) by major rating agencies.
  • Within two years of being thus downgraded, fallen angels as a group have meaningfully outperformed the broader high-yield index and all three quality subgroups (Figure 1).
  • Some of fallen angels’ excess return versus the index was attributable to…
MARKETS

ARCHIVED

Robert Burn
Rob Burn
CFA
Fixed Income Portfolio Manager
Boston

European, global, and US high-yield indices declined around 20% from the start of the year through the peak in spreads on March 23. However, extraordinary global monetary and fiscal stimulus measures in response to the COVID-19 crisis have since helped high-yield markets recoup a sizeable portion of those losses. Members of Wellington’s High Yield Strategy Group met recently to discuss their market outlook, including perceived risks and opportunities, in the wake of this extreme volatility.

Economic data buoyed by stimulus

While the worst of the economic shock is likely behind us, the question now surrounds the trajectory and timing of a recovery. Our base case is for a two-stage recovery that begins with a strong rebound from pent-up consumer demand as lockdown measures are eased, followed by a drawn-out recession.

Purchasing managers’ indices (PMIs) — economic indicators derived from surveys of private companies — remain depressed across nearly all geographies. However, we believe…

CORONAVIRUS
MARKETS

ARCHIVED

Michael Hong headshot
Michael Hong
CFA
Fixed Income Portfolio Manager
Boston
Konstantin Leidman headshot
Konstantin Leidman
CFA
Fixed Income Portfolio Manager
London
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