- Corporate fundamentals have had a good run – but it may be time to be more cautious.
- Dispersion could be a key theme for 2024. Credit analysis will come to the fore as an expected economic slowdown winnows out winners from losers.
- The maturity wall: Not what you might expect. Refinancing should be manageable even at higher rates with a bit of corporate belt-tightening.
- The energy transition won’t finance itself. Investors have a crucial role to play in addressing the challenge of climate change.
Market conditions will reassert the value of fundamental credit analysis in 2024 as investors seek opportunity in sorting winners from losers, according to speakers at the Federated Hermes Fixed Income Forum in London on 14 November.
In a presentation highlighting the potential of an unconstrained credit approach, Fraser Lundie, Head of Fixed Income – Public Markets, noted that while inflation expectations are normalising, there is a risk of the market turning from an inflation fixation to suddenly not being concerned at all. “Growth concerns have supplanted inflation as the main event for 2024,” he said. “The good news is that none of this is an overnight shock and investors and corporates have been able to factor in different expectations.”
One well-anticipated anomaly, according Lundie, is the coming ‘maturity wall’, where some 50% of the high yield credit universe is expected to refinance within the next three years. Here, he said, some companies have managed to extend maturities in the hope of interest rates coming off their current highs. Elsewhere, companies have been able to access private markets as an alternative to traditional issuance. In both cases, he said, even with the expectation of higher rates, the maturity wall should be manageable, particularly for those companies with stable foundations. “It will be a case of corporate belt-tightening,” he said. “Less scope for M&A. Fewer dividends or buybacks. But it should be manageable.”
Nachu Chockalingam, Senior Credit Portfolio Manager, said 2024 would likely be a time to be more cautious around corporate fundamentals. The flipside of the coin, she said, was that this meant the door would now be open to investors able to identify value across the credit spectrum.
Orla Garvey, Senior Fixed Income Portfolio Manager, agreed with this view, highlighting how the Sustainable Investment Grade team had begun to explore nuanced sector or country allocations in light of an expected slowdown in 2024. Financials were one area of possible opportunity, she said, given current valuations.
Andrew Lennox, Senior Portfolio Manager, discussed the potential for uncorrelated returns in the ABS and CLO markets, particularly given the scope for upside from floating rate notes in a higher-for-longer rates environment. While the underlying assets of both ABS and CLOs could be affected by tightening in 2024, a current CLO default rate of zero offered head room for the asset class, while also underlining the need for fundamental credit analysis, he added.
Annual % change in consumer price indices
Developed market PMIs – Manufacturing, services, composite and global composite
Companies that recognise the new sustainability paradigm will have first-mover advantage.
The sustainable fixed income view
In the second breakout session of the day, Mitch Reznick, Head of Sustainable Fixed Income, highlighted the crucial role investors have to play in facilitating the energy transition. With evolving regulations, shifting value chains and changing consumer preferences, he said, the companies that best understood momentum towards sustainability were the ones that were also best placed to meet the financial objectives of investors.
“Companies that recognise this will have first-mover advantage. They’ll be the resilient companies of the future,” he added.
In the second part of the session, engagers Jake Goodman and Sarah Swartz along with Head of Corporate Credit Research Audra Delport talked through the benefits of engaging with bond issuers on sustainability – not just for investors but for the companies themselves.
Delport explained the rationale behind engagement from the corporate point of view. For many, she said, there is a financial benefit to being seen as a sustainable leader. “It doesn’t apply to everyone but there’s a significant cohort of companies that want to be seen to be active and receptive in this space. When consumer behaviours change, or the value chain evolves or regulators begin to enforce new rules, they understand the benefit of being in the vanguard.”