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Opportunities for Investment: What the Changing Credit Landscape Means for You

Posted by: 
Sonal Mitra and Prateek Sogani
 | Apr 2021

The events of the last year have made it more difficult than ever to identify opportunities for investment. And the challenges aren’t over yet.

 

Sovereign bonds yielding negative returns, a greater focus on ESG integration, and the changing fates of various industries make for a complicated landscape to navigate.

And although a credit market recovery is expected in 2021, it’s likely to be uneven across geographies and sectors – which means investments need to be carefully considered and supported by the right insights.

To help provide some clarity, we asked our financial experts to highlight investment opportunities for credit investors during the recovery process.

A move down the risk spectrum

At the end of last year, the world’s negative-yielding debt swelled to a new record of ~$18 trillion. This trend is largely due to low interest rate regimes and financial stimulus packages provided in the wake of COVID-19. Despite concerns being raised around growing inflation and commodity prices in Q1 2021, the Federal Reserve is determined to keep interest rates near zero through 2023 as evidenced at its meeting in March 2021. Consequently, investors seeking higher return and optimistic of recovery, will likely move down the credit spectrum towards higher-yielding, lower-quality bonds.

tight-rope-walker-in-city

In this year, we may witness an outperformance of lower-quality B- and CCC-rated bonds, as opposed to BB rated bonds which performed better than lower quality tranches in the pre-pandemic year. This can be seen in the total return by ratings in January 2021, where CCC and lower-rated bonds outperformed their higher-quality peers by a considerable margin.

Rating

Price Change

Price Change

High-yield

-0.09

0.38%

BB

-0.36

0.05%

B

-0.28

0.22%

CCC/CC/C

1.69

2.36%

Source: S&P, ICE Data Indices LLC; January 2021

Further, continued liquidity measures by the global central banks would result in a weaker US Dollar supporting higher capital flows towards emerging market debt. According to the Institute of International Finance (IIF), non-resident portfolio net inflows to emerging markets totalled $67 billion in debt instruments and ~$18 billion in equities in the first two months of 2021—marking February 2021 as the eleventh consecutive month of net positive flows to emerging markets.

Widely uneven recovery across industries

The various lockdowns over 2020 have resulted in mixed fortunes for different sectors. Whereas travel, entertainment and hospitality were all negatively impacted, other sectors such as healthcare, home improvement and supermarkets fared better.  

Now with vaccines rolling out, we can expect lockdowns to ease, thus changing the fate of sectors such as transportation, leisure and entertainment. Further, some of the money that consumers have been spending on healthcare and supermarkets in the last year is likely to be filtered into these industries instead, meaning the hardest-hit sectors will start outperforming those that have so far weathered the storm.

 

Source: ICE Data Indices LLC; data as of 25 November 2020

Additionally, it’s well publicised that at the start of the pandemic, digital transformation advanced roughly seven years in a matter of months. We expect the technology sector to remain in favour over the medium term.  While the higher requirement of networking, cloud computing and cyber security solutions will continue to drive growth in this sector, growing digital transformation will create opportunities in other sectors as well.

Side view of customer handing credit card to cashier

One such sector is healthcare, which will be driven by telemedicine, artificial intelligence (AI)-enabled medical devices, ‘big data’ applications in on-demand healthcare, and block chain-enabled electronic health records. This is evidenced, for example, by the strong funding support for a tech-driven health insurer, Oscar Health, which raised ~$1.6 billion from private funding sources and secured another ~$1.4 billion from its IPO in March 2021. It is also evident that the default rates in the US healthcare domain have reduced significantly across the sector from their highs of 2020.

Source: S&P Global

Another new normal – integration of sustainable investing

The pandemic has significantly increased investor interest in sustainable investing, placing greater emphasis on ESG requirements. Sustainable bonds (green, social and sustainability combined) are expected to hit a record of $650 billion in 2021 as compared with ~$300 billion in 2019.

In the US, initial executive orders and political alignment suggest that the Biden administration will heavily support green infrastructure and climate change initiatives in the coming years. Similarly, the European Union is rolling out green stimulus packages alongside numerous national programmes that will benefit clean transport and green energy sectors. 

The upshot is, the companies and sectors that are well positioned to adapt to the latest ESG trends will see a lot of traction this year, while the new environment friendly policies could adversely impact sectors such as oil and gas, auto, utilities, construction and manufacturing.

Paper Cut Out Human Figures Around The Stack Of Hundred Dollar Bills

This means investors need to look beyond the financial potential of their investments, and simultaneously assess a prospect’s ability to align with these new expectations. Several industry studies demonstrate that ESG integration can help in mitigating issuer, credit and default risk in fixed income investing.

Want further insights?

At The Smart Cube, our financial services experts work alongside credit teams – both public and private – across the world, helping to ensure the right investments are made at the right times and with the right outcomes.

Learn more about our Credit Research offering and see how we can help your organisation.

Co-authored by: Sonal Mitra and Prateek Sogani