An Alternative Approach to Credit Investing
By Brian Lieberman, Portfolio Manager at Muzinich & Co.
Global fixed income continues to experience uncertainty in the new environment that Covid-19 has brought with it. Credit markets rallied since the March lows in response to the support provided by central banks and governments. Despite some economic activity resuming and positive macro data, forward-looking expectations remain challenged.
As the outbreak continues to evolve and the reopening of economies is slowing pace, and sometimes even reversed, market volatility is likely to remain high. The question for many investors in credit markets is how to capture the current value of yields and credit spreads whilst containing volatility.
Avoiding Defaults by Active Management
We believe that a long/short approach to credit investing seeking to exploit sources of return away from carrying and pure market beta by utilizing a broad set of instruments may offer the potential to capture returns, preserve capital and help investors to navigate the current markets with moderate volatility.
In this context, a long/short credit approach combines the upside potential through direct and actively managed exposure to credit markets, specific sectors and issuers, while portfolio hedges through dynamic management of short positions aim to materially reduce the downside risk and volatility that an uncertain economic environment will inevitably generate in the next few quarters.
We believe active management is important when attempting to avoid defaults or capitalizing on them. It would be prudent to remain selective when investing in industries impacted by COVID-19 and focus on the liquidity profile and the value in the capital structure. Understanding a company’s liquidity profile and ability to weather the next few months will be key, we believe, against a backdrop of Covid-19, and increased political tensions.
Exploiting Continued Uncertainty
Many companies took advantage of open markets and issued debt to add cash to balance sheets and shoring up liquidity to weather the coming months. This has resulted in a few near-term maturities. There appears to be a tug-of-war between the technicals created by stimulus packages and the fundamental macroeconomic picture, which potentially offers new opportunities in portfolio selection and rotation.
Risk managers adapt to – and, capitalize on – imbalances of fundamentals, valuations, and technicals. We believe that continued uncertainty creates opportunities to deploy many of the tools that can drive overall consistent performance. Both long exposure and arbitrage positions could benefit from such dispersion going forward.
Attractive Buying Opportunity
Spreads have retraced by about half from their widest levels reached in March but remain both significantly wide of where they began 2020 and their historic averages. Uncertainty remains, but we believe government liquidity programs and signs of reopening of the economy could prevent spreads from retesting lows. More normalized economic activity is required for spreads to tighten toward historic averages.
Whilst we believe current spread levels represent an attractive buying opportunity for the long-term, we expect volatility in the short to medium term. In our view, as uncertainty will remain a long/short approach with an extended toolkit may be well equipped for the challenges ahead.
Brian Lieberman has been a Portfolio Manager at Muzinich & Co. since 2014. He has 11 years of corporate credit experience. Brian holds a B.A. in Psychology from Princeton University and an MBA from Emory University.
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