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Credit investing in the coronavirus era: 360°, Q3 2020

What is our current view of fixed-income markets? And where do we see the best relative value? In our latest edition of 360°, Andrew ‘Jacko’ Jackson, Head of Fixed Income, and his team of specialist investors considers the areas that have the potential to deliver superior risk-adjusted returns.

Looking for Goldilocks: not too hot, nor too cold

The coronavirus pandemic has placed credit markets in a precarious position. Currently, there is a tug-of-war between deteriorating market fundamentals and the incessant injections of liquidity and support from financial banks and governments.

Market fundamentals are now in a far worse position than in February. The market bounce was no natural rise from the bottom, but a massive upwards boost that was triggered by the largest, fastest and most coordinated central-bank intervention in the history of modern finance.

Yet coupled with these risks, there are metrics which indicate that markets are not in a uniformly poorer state – nor that the situation is so bad that fixed-income investors can’t find pockets of good value. In fact, the crisis has highlighted both the relative resilience and value of fixed income as defensive asset class.

With both perspectives in mind, we find ourselves in the middle ground. Overall, we have a positive view on credit – but with caveats. For years, we heard about the Goldilocks economy in which credit thrived when growth was neither too hot nor too cold. Now, credit markets should perform in a scenario that is not too safe, nor too risky.

Overall, we expect ongoing volatility, corporate casualties, for sectors to fight for survival and for an appealing trade-off of risks and returns. Importantly, we believe that both public and private credit markets offer the chance to seek relative value and see a wealth of opportunities to seek alpha in this new coronavirus era.

Relative value between asset classes

Every quarter, we compile a relative-value framework of fixed-income assets across the public and private credit spectrum, ranking them by 11 different factors. When we compiled our last report, uncertainty had peaked, and our framework favoured more defensive, higher-quality and liquid exposures.

Figure 1. Our Multi Asset Credit relative value framework, 30 June 2020

Federated Hermes, as at 30 June 2020

Since then, a rally in higher-quality exposures, an improved economic outlook and the re-emergence of an illiquidity premium in areas of private credit means the rankings have shifted. For more detail about how our ranking has changed over the last quarter, click between the credit classes below.

The spreads on liquid cash bonds have widened. Investment grade has recovered the most, aided in part by downgraded names moving into the high-yield universe.