Will the outlook for credit remain constructive or will 2017 bring a catastrophe?
With the Federal Reserve implementing only its second post-financial crisis rate hike earlier this month and bonds rallying following the victory of Donald Trump, where should investors focus?
In this round-up, Citywire Selector pulls together the views of investment specialists focusing on the credit market, to see where they expect to allocate in order to bolster returns in the coming year.
Don't gamble with defaults
Hermes’ co-heads of credit, Fraser Lundie and Mitch Reznick, said the hunt for high yield, combined with widespread low-interest rates has prolonged the life of moribund companies.
The pair believe this has left creditors with minimal residual recovery values when the companies have finally collapsed.
‘Because downside risks are now far greater than in the past, we do not believe that gambling with default risk to deliver performance makes sense.’
‘Rather, having the flexibility to capture valuation anomalies that emerge when looking down to security level across credit markets on a global basis, is a better way to generate strong risk-adjusted returns.’
‘Despite this year’s rally, we see plenty of opportunities in 2017 but must reject traditional credit management methods and instead cut our own path.’
The duo also said, in order to protect capital, it would make sense to reduce exposure to duration and build defensive strategies from credit risk.
‘As we look into 2017, we believe that focusing on the fixed-income characteristics of credit management will be essential to outperformance.'
Elsewhere, Pimco’s CIO for asset allocation and real return, Mihir Worah, and portfolio manager Geraldine Sundstrom, said recent market developments have caused them to view TIPS (treasury inflation-protected securities) rather than nominal government bonds, as the ‘risk-free’ asset.
‘Income generation still remains the core focus of our multi-asset portfolios. We continue to believe high-quality bonds offer an attractive means to escape negative-yielding assets, without taking excessive risk at a time when we believe recession probabilities are still fairly low.’
‘In particular, our overweight to credit is focused on non-agency mortgage-backed securities, which will likely benefit from an ongoing recovery in the housing market and remain well-insulated from many global risks hanging over financial markets, leading to low-to-modest correlations with other spread sectors.'
The pair said they have also added senior, short weighted-average-life CLOs (collateralised loan obligations) as another source of high-quality yield.