by Brad Tank, Chief Investment Officer—Fixed Income, Neuberger Berman
Last week’s very promising news on coronavirus vaccine trials, which we had anticipated, sent a wave of optimism through markets. Alongside a huge style rotation in equities, we saw a sizable bid for beaten-up, coronavirus-exposed industries and issuers in credit.
We urge caution, however.
Those who’ve followed our blogs and webinars throughout 2020 know that we have consistently advocated credit exposure. We think credit will be an attractive place in 2021, too—but in our view, the conditions will require even greater levels of selectivity and flexibility from investors.
Once the virus hit markets and central banks stepped in with support, 2020 became a good year for both credit beta and duration. Nonetheless, there was plenty of alpha to be made from credit selection and sector allocations as conditions evolved.
Our initial trade was to “follow the Fed,” favoring attractively priced investment grade credit as issuance set new records, and the “TALF 2.0” opportunity in asset-backed markets. That moved on to the much-feared BBBs and “fallen angels” as the recovery took hold. Then we got a rotation into high yield, then tradable bank loans, and ultimately the beginnings of a comeback for higher-quality CCCs.
While these rotations were happening, there were also countertrend, risk-off moves that opened up new industry, sector and issuer value opportunities in a generally bullish market. Much of June, the first three weeks of September and the end of October stand out as volatile times with severe corrections. Investors who rebalanced portfolios by selling into tightening spreads had dry powder to take advantage of those opportunities.
We still believe there are potential returns to be made from investment grade beta, and especially high yield and emerging markets debt beta. But those attributes of selectivity, flexibility, opportunism and nimbleness that helped to generate alpha this year are likely to be still more important next year.
Nimble, Selective, Flexible
Spreads are again relatively tight. The U.S. High Yield Index is now back below 500 basis points. And while last week’s news was encouraging, the logistics of vaccine distribution mean that the coronavirus and its potential impact on business and the economy are likely to be with us until well into next year.
That means the ability to trade tactically amid expected volatility, and rotate between sectors, is likely to be an important source of relative value around the margins of core credit portfolios.
It also makes the case for considering riskier parts of the market, among the CCCs, while remembering how it important it is to be selective there, given that the coronavirus will likely be with us for months to come.
In addition, it implies the ability to seek out niche markets, such as corporate hybrid securities or taxable municipal bonds, which might offer pockets of value because they remain little known or understood outside the regions where they are chiefly issued.
And finally, it means thinking about currencies as a source of additional return potential—and not just unrewarded risk.
With central banks likely to hold short-term interest rates at or below zero, and the potential for yield-curve control to be applied more widely, investors unable to express views on international growth and inflation differentials through Treasury markets are likely to do so in currency markets instead. Any resulting volatility could be an important source of opportunity during 2021, making a strong case, in our view, for dynamic currency-hedging programs and absolute-return overlays for fixed income, equity or multi-asset portfolios.
2020 With the Volume Turned Up
If we were to sum up our expectations for credit investing in 2021, we might argue that investors should think of 2020 with the volume turned up.
There is likely to be credit beta to harvest, but we believe the most successful investors will embrace the flexibility to “go anywhere”—across ratings, sectors, regions, currencies and niche markets—and the fundamental selectivity to do so prudently.
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