The current macroeconomic outlook looks far from perfect for bond investors. As a sustainable global economic recovery appears to be taking shape, inflation has reached worrying levels. As a result, central banks have shifted to a more hawkish stance, and reduced accommodative policy measures can be expected to put upward pressure on real rates.
In this environment, nominal government bond yields are likely to be skewed upwards through 2022 and 2023, and there will be a greater threat of steepening yield curves. However, now is not the time to reallocate fixed income securities. Unlike the ‘taper tantrum’ of 2013, the gradual reduction in quantitative easing measures should involve fewer ‘crises’ on the part of market players, as the removal of emergency measures and programs has been more widely communicated and expected. during this cycle.
Instead, the volatility induced by the shift from a very accommodative policy to a more standardized policy offers an opportunity to invest in credits at more attractive valuations. In addition, certain types of debt, such as floating rate assets and lower quality fixed income securities, are poised to generate attractive returns in this environment.
With headline and core inflation likely to stabilize in a range slightly above pre-pandemic levels, floating rate bonds are now our largest allocation in the global market. NB Global Monthly Returned Funds (NBM). As the name suggests, variable rate loans carry variable interest rates, typically set every three months at a margin above the benchmark interest rates. It is interesting in the environment of rising rates. In addition, over the past 32 years, approximately 99% of the principal of variable rate loans has been returned to investors.
From the point of view of the issuer, RSA Security (RSAS.O), a leading US provider of IT risk management and cybersecurity solutions, is an example of a company offering an attractive variable rate loan. The company’s software is designed to effectively detect and respond to advanced online attacks, manage user access control, and reduce cyber fraud.
With the pandemic-induced acceleration towards remote working resulting in greater vulnerability of business cybersecurity, RSA’s offering is becoming increasingly valuable for businesses. In fact, the company now sells its products to more than 12,500 global corporate customers, 90% of which are Fortune 100 organizations.
Along with floating rate loans, lower quality fixed income securities have generally performed well in times of rising inflation and steepening yield curves. This debt offers low cost hedging against inflation, attractive relative returns and broad diversification across sectors and themes.
The factors underlying the tightening of credit spreads – or the narrowing of the yield spread between corporate and government bonds – are improving issuer fundamentals and low and declining default rates. decrease. They are unlikely to be affected by the changing landscape of central banks in the near term. Therefore, we expect credit spreads in the credit and securitization markets to continue to account for a low level of expected loss, as has been the case in previous episodes of the credit cycle in the early stages of economic expansion.
Loans in particular are well positioned to benefit from the search for yield – with high relative returns, short duration, improving issuer fundamentals and strong demand for secured loan bonds (CLOs). CLOs are securities backed by a pool of business loans, often with a low credit rating. CLO structures in general – and lower rated BB CLOs in particular – were again largely unscathed despite the volatile conditions of 2020.
This year, CLO issues have been very strong, as the search for yield continues unabated. While CLO activity could moderate, it should remain relatively robust for the remainder of the year and beyond.
There are also many opportunities to invest in lower quality credit than companies well positioned to take advantage of the pandemic recovery. We invested in the debt of Carnival Cruise Line (CCL.) – confident that its credit position would improve relative to similar companies – based on the cyclical and competitive nature of the industry and Carnival’s better balance sheet.
Former customers familiar with the cruise experience and with excess savings will boost bookings and prices for major operators as cruise vacations return. Based on feedback from management teams, reservations for future periods confirm this.
Likewise, we have a positive view of sustained private equity Pizza Express, the second largest casual dining group in the UK. The company has forged a strong and popular brand, with a strong position in a market that is expected to rebound strongly over the next 12-18 months. Having entered the highly indebted Covid period, the group completed a financial restructuring at the end of 2020, significantly reducing its gross debt. It is also helped by the closings of competing restaurants over the past 18 months in a previously over-supplied market.
These two credit issuers – both of which have the theme of reopening in common – feature in our diverse portfolio of more than 150 individual issuers operating in a wide range of industries and geographies. While cost inflation and supply chain issues will remain in the spotlight for the remainder of the year, heightened volatility in non-investment grade markets offers an attractive entry point. Investors need to act quickly, as the favorable macroeconomic environment and strong global demand for yield suggest this opportunity may be short-lived.
Simon Matthews, senior portfolio manager for non-investment grade credit, NB Global Monthly Returned Funds (NBM).
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