Economic and Market Commentary

High Quality Credit Opportunities

2/27/2024

Mark Kiesel

CIO Global Credit Mark Kiesel and Jason Duko, Portfolio Manager, discuss why now is the time to invest in high quality global corporate bonds, loans and high yield credit given current market dynamics.

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Text on screen: Mark R. Kiesel, CIO Global Credit

Mark Kiesel: We think it's an excellent time to invest in high quality corporate bonds, and a lot of this is basically because of the strength of the private sector, the consumer and businesses are doing quite well. The economy's proven to be very resilient. Most importantly, there's catalysts for lower yields ahead. We think that growth has peaked and we're going to start to see a slowdown in growth.

Not a recession necessarily, but clearly a slowdown. And also inflation is clearly coming down, so with that, we should see over the next 1 to 2 years lower yields.

Text on screen: TITLE – High Quality Credit: May outperform equities based on current valuations with potentially lower volatility; SUBTITLE – S&P Earning Yield vs. Credit Yield

Image on screen: A line graph shows the S&P forward earnings yield versus credit yields rated BBB and BB, over the period 2008 to 2024. For most of duration of the chart, S&P yield is higher than those of BBB and BB. In early 2024, the yield for BBB credit is about 6.2%, above that of the S&P and BB yields, which are around 5.6%. The yield for BB credit started to eclipse that of the S&P yield in early 2022. The yield for BBB credit surpassed that of the S&P in early 2023. Over the time period, the chart also shows how yields have trended downward over time. The S&P yield starts in 2008 at around 8%, and trends down to the 4% to 6% range between 2020 and 2024. Yield for BBB credit starts at around 6.5% in 2008, bottoms at around 2% in 2020 and 2021, then rises to its 2024 level. Yield for BB credit in 2008 is at 8.5% in early 2008, spikes to 10% later that year, then trends toward a bottom of about 3% in 2021 before moving upwards.

At the same time, we think investors can earn near equity returns by investing in bonds today. These yields are basically at 15-year highs. If you look at both nominal and real yields, we haven't seen these yields in 15 years.

So this is an excellent time for investors to own high quality bonds, benefit from potential price appreciation as those yields go lower, and also invest in very high quality companies where the fundamentals are very strong.

Text on screen: Jason Duko, Portfolio Manager, U.S. Leveraged Finance

Jason Duko: When you look at the high yield index as an example, you know, this composition of index has really improved the last number of years, and even last year we saw a lot of rising star activity.

Text on screen: TITLE – High Yield: Composition mix has improved in credit quality and security: Two charts are on screen: The left chart shows how credit ratings BB (blue), B (green) and CCC & Lower (maroon) have shifted from 2008 to 2024. In 2008, the ratings were the lowest by percentage: BB, 34%; B, 43%; and CCC & Lower, 23%. Over the next 15 years, credit quality grows (BB and B), while, CCC & Lower drops. In 2024, high quality BB accounts for 45%; B, 40%; and CCC & Lower, only 15%. The second chart at right, shows the percentages of secured debt across credit quality from 2018 to Jan. 2024. Using the Bloomberg High Yield Index as the proxy for the market, the chart shows that 33% of the market is secured debt backed by direct collateral assets.

Where the index stands today, 50% is BB rated, a third of the index is secured, and as Mark mentioned, the underlying borrowers themselves are performing quite well from a fundamental perspective.

And given that we're in the late cycle dynamics potentially this year, we think that they have a lot of downside protection being offered at the levels that we're seeing today.

Mark Kiesel: So we're super excited about the global opportunities in corporate bonds, bank loans and high yield around the world and in emerging markets.

There are companies that we can invest in today with huge barriers to entry, very high profit margins and secular tailwinds and growth. When you look at the U.S. economy, the strength really is the consumer. And while goods spending is slowly decelerating, the service spending is still incredibly strong. In addition, guess what?

The business traveler's back.

Text on screen: Focus on adding alpha

Image on screen: A diagram breaks down alpha added to various sectors for investment grade and high yield, shown in two columns. For each of the asset classes, a series of horizontal bars plots the alpha for different sectors or markets. Each bar is a scale, with red on the left signifying negative alpha, and green on the right representing positive alpha. The scales are not numeric, but instead show relative alpha among the sectors. For investment grade, shown in a column on the left, alpha is highest for airlines and leisure, with a vertical blue dash plotted more than halfway into the green section, further right that any other sector plot. Five other groupings show a little less alpha, and are roughly similar to one another: financials/banks, REITs, utilities/defense, healthcare, and telecom/cable/towers. Industrials/autos, retailers and technology show negative alpha, with the plot in the red section. The right-hand column shows relative alpha for high yield/loans. Gaming and leisure/cruise operators shows the most alpha, with the plot in the center of the green section. Five other groupings show a little less alpha, yet even closer to the center: financials, pharma/healthcare, defense, LNG pipelines, and utilities. Wirelines and retailers and show negative alpha, with the plot in the red section.

So if you look at companies like airlines, hotels, gaming, those margins are expanding.

And finally, if you look at the banking industry, there's many opportunities around the world to own high quality banks that are highly profitable, very high capital ratios.

This is a pure play on the strength of the economy. And again, with the economy being so resilient, we find many opportunities in banks and financials around the world.

Jason Duko: I think when you think about these sectors, you know, they are benefiting from the tailwinds that Marc mentioned earlier. And with our bottom up credit selection, we already have identified these as potential rising star candidates in the sectors such as gaming and cruise lines.

And our credit analysts have already rated these credits, investment grade effectively, and the rating agencies are just now catching up. And that really leads to a lot of spread compression and alpha generation, and it's just one example of where our active management is kind of ahead of the agencies and generating that alpha that we are always striving for.

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Disclosure

IMPORTANT NOTICE

Please note that the following contains the opinions of the manager as of the date noted, and may not have been updated to reflect real time market developments. All opinions are subject to change without notice.

All investments contain risk and may lose value.

The credit quality of a particular security or group of securities does not ensure the stability or safety of an overall portfolio

A rising star is a bond that is rated as a junk bond but could become investment grade because of improvements in the issuing company’s credit quality.

Alpha is a measure of performance on a risk-adjusted basis calculated by comparing the volatility (price risk) of a portfolio vs. its risk-adjusted performance to a benchmark index; the excess return relative to the benchmark is alpha.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice.

This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

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