[Part 2 of 2]
With the Covid-19 vaccination program gaining momentum in the United States, acceleration in growth is expected as the national economy finally fully reopens. Rob Waldner, Chief Strategist and Head of Macro Research for Invesco Fixed Income, predicts that the economic recovery in the United States will exceed growth by 7% in 2021. What he calls at this point a “macro-factor framework” includes these high growth expectations, as well as subdued inflation and policy. accommodative monetary policy.
“It’s a good environment for financial markets as a whole in terms of liquidity and stability,” says Waldner. “It’s also very good for things related to growth, like earnings and credit quality. In a world where Treasuries have negative real yields – we’re at about -0.6% real yield for the 10-year Treasury in the United States – there are going to be opportunities elsewhere in fixed income. .
In this context and to explore the opportunities in the private credit markets, he recently spoke with Scott Baskind, Head of Global Private Lending and Chief Investment Officer of Invesco’s Global Private Lending Platform, for Part 2 of our series focusing on how institutional investors can make their fixed income portfolios work harder and take advantage of the current scenario.
What are the opportunities like in the private fixed income universe?
Scott Baskind: There has been a drastic shift around business from a trust standpoint, not just in the United States, but around the world. We see opportunities in private credit that cut across several themes. One is the more liquid part of the substandard credit space in bank loans. In addition, we see opportunities in the realm of direct lending and private debt, defined by lending to middle market companies, and in the troubled credit spectrum. We have seen a significant recovery in many sectors and this has supported credit assets and risk assets overall.
Tell us more about your perspective on the advisability of bank loans.
Baskind: There is a need for income among global investors, and this is common in conversations with our investor base on the more liquid part of traditional bank lending. Bank loans have priority in the capital structure, secured by 100% of the assets of an underlying business. Their floating interest rates lead to some of the opportunities we see today. Historically, bank lending has been defensive in nature – we have only experienced two years of negative total return in the past three decades, and this is largely supported by the high credit spread above a component of floating rate.
It is also important for investors to consider whether in the broad space of bank lending to mitigate and profit from the interest rate environment we find ourselves in today – and one towards which we might. lead us over the next few years. Bank loans float as interest rates rise, so from a duration perspective, they do not share negative implications with fixed rate instruments.
Do you expect bank loan issuance to remain strong?
Baskind: We do. Bank lending for mergers and acquisitions is one of the primary ways that U.S. and global businesses use capital markets, and we expect this activity to continue to be robust. And for investors looking for capital protection, we continue to see strong inflows into bank lending as an asset class. This flow picture has changed dramatically with less political uncertainty in the wake of the US general election and is also reinforced by economic growth and concerns about an inflationary environment. In short, with currently high incomes in a floating rate environment, our global clients are enthusiastically engaging in bank lending.
Earlier you mentioned direct loans and distressed credit as areas of opportunity as well. What do you see that makes you believe that?
Baskind: Many illiquid private credit assets, such as direct loans, do not exhibit the same performance data as public markets and, therefore, can act as a buffer for portfolios and for asset distributors. And as we have seen a tightening of bank lending liquidity, opportunities have arisen in the realm of direct lending as investors continue to move from public to private markets due to the search for income.
In the struggling market, we have a strong focus on small and mid-cap companies, where growth is starting to present operational challenges. Their challenges are less likely to result from the business cycle and more likely to be caused by idiosyncratic events. These companies don’t have the same buffer or liquidity as some large companies, and when idiosyncratic events arise, they can easily end up with over-leveraged balance sheets. In these situations, you can buy them at very low prices relative to par and ultimately create the potential for very substantial returns for investors.
There is a view that the opportunity in troubled credit has passed. You obviously disagree with this from a top point of view – but is it true to some extent?
Baskind: This is quite true in the large liquid part of the market. Government intervention helped consolidate liquidity and strengthen balance sheets. Many companies in the small and mid-cap segment are owned by private equity firms and were not eligible for some of the loans that were readily available to many large companies. As a result, the need for liquidity and new small and mid-cap lenders provides investors with a continued distressed credit opportunity.
How does your team think about asset allocation in private markets in different market cycles?
Baskind: We spend a lot of time thinking about asset allocation from a dynamic perspective, that is, throughout a full cycle. Historically, many investors have focused on individual verticals, but interest is growing around multi-strategy portfolios. The goal is to have the ability to maneuver successfully through the transitional periods within a cycle and between one cycle and the next. For example, having the most liquid part of the credit space bearing the day in the strongest part of the business cycle, then being able to rebalance quickly and dynamically to add the less liquid components of credit as the end of cycle is coming to an end and perhaps heightened volatility emerges as we enter a period of recession. In this scenario, investors are looking to earn returns and invest in volatility. It takes dynamism to move from the highly liquid part of the credit universe – bank loans and high yield bonds – to a less liquid direct lending or private debt market, then struggling when the opportunity arises. present. Ultimately, this can prove to be very beneficial for investors.
When looking for returns and taking more risks in this type of environment, what are the trade-offs?
Baskind: From a credit risk perspective, it’s important for investors to think about diversification across the risk spectrum. There is a general need to downgrade in order to seek income. However, we prefer to view it as being more selective in the sense of desirability. In the non-investment grade space, for example, there are opportunities in BB and B credits, as well as in CCC and C credits. In each of these compartments, the bifurcation is quite significant, especially when you go down. quality. We are constantly on the lookout for higher conviction opportunities to take risks and for companies that have taken the leap. The economy is quite credit risk friendly at this point, and the ability to invest in companies that have emerged from the depths of the business cycle could help in terms of risk taking. The environment we find ourselves in today is not going to last forever and being able to go back and forth across the liquidity spectrum – which also dictates risk in some ways – is going to be quite critical. The health of the underlying companies will ultimately dictate the level of risk investors should be prepared to take.
How is ESG a factor in private credit markets?
Baskind: Our philosophy is that ESG considerations are credit risks for an issuing company. We started rating companies for ESG in the private space about 10 years ago, and today we are rating well over 800 unique issuers. What is quite different between private and public markets from an ESG perspective is the lack of readily available information on private companies. Part of our strength as a private credit team at Invesco lies in our interactions with management teams, in the due diligence of thousands of companies, and in their rating both from a credit risk perspective and from a credit risk perspective. through the prism of ESG factors. This represents a significant improvement in our underwriting standards over time.
Read Part 1 of this story to find out how to make your fixed income portfolio work harder in the public markets.
This article is intended for U.S. institutional investors and accredited investors in Canada only. Accredited investors within the meaning of Regulation 45-106. The content was developed in March 2021. TThis is for informational purposes only and does not constitute an offer to buy or sell financial instruments. As with all investments, there are inherent risks associated with it. This should not be taken as a recommendation to buy an investment product. Please obtain and carefully review all financial documents before investing. The opinions expressed in this article are those of the authors and are based on current market conditions and are subject to change without notice. These views may differ from those of other Invesco investment professionals.
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