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Credit Chronicle: A long-awaited return of attractive yield

16 January 2023 Ninety One

The Q4 2022 investment review from Ninety One’s Developed Market Credit team finds that despite a challenging year for investors, a widespread sell-off has created attractive opportunities for the long-term

The last quarter of the year got off to a slow start for credit investors, but brought with it welcome relief – between US CPI inflation falling, the Fed reducing the pace of interest rate hikes and China moving away from its zero-COVID policy, sentiment improved and US Treasury yields retreated from recent highs. The core themes of high inflation, tight monetary policy and geopolitical uncertainty remain front of mind, but recessionary fears have overtaken and become the primary source of concern among investors.

Darpan Harar, Co-Portfolio Manager, Multi-Asset Credit, Ninety One: “After last year’s dramatic reset in credit markets, which saw yields and spreads rise well above historic averages, the driving forces behind this re-pricing are finally shifting. Fundamentals are now increasingly in the driving seat and the influence of market technicals[1] is receding”.

A combination of rising government bond yields and higher credit spreads made 2022 a brutal year for credit investors, with major bond indices experiencing their worst year on record. However, this widespread sell-off has created attractive opportunities for longer-term credit investors. One such example is the improvement in the income profile of the credit asset class, especially when compared with equities, with the gap between corporate bond yields and dividend yields in equity markets at the highest level in over a decade.

US investment-grade corporate bond yields versus S&P Dividend Yield

Source: Bloomberg, 31 December 2022. US IG = BofA US Investment Grade (C0A0). For important information on indices, please see Important Information section.

Through the final quarter, both investment grade (IG) and high-yield (HY) credit rallied significantly, with Europe outperforming as fears of dire energy security risks were allayed. Returns were even stronger through mid-December; however, gains were given up as investors digested hawkish central bank outlooks amid thin market liquidity at the tail end of the quarter. CLO and other securitised product spreads also recovered, having widened amid market disruption following the UK mini-budget at the end of Q3. In EM corporate credit markets, Q4 was the only quarter in which the market finished higher than where it started.

Harar continued: “Now that market participants are adjusting to the new interest rate regime, the focus is starting to return to company fundamentals (i.e., company health and durability); we expect the real impact of higher rates and lower growth on corporates to take over from technical considerations as the main driver of performance. This dynamic will likely lead to increasing dispersion between winning and losing companies in what is a more challenging operating environment – as such, investors seeking to capitalise on attractive credit market valuations need to be very selective in their approach.”

“Opportunities are present, but selectivity remains key, particularly as default risk will increase from historically low levels in 2023.”

To read the Credit Chronicle in full, click here.

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