The Great Credit Dilemma: When to Quit After Historic Rally?
The Great Credit Dilemma: After Historic Rally, When to Quit?
(Bloomberg) -- After mopping up bumper returns from central bank stimulus for the best part of a decade, credit investors in 2018 look cornered.
On the one hand, spreads have ground so low that further upside is looking more and more limited as central banks exit bond-buying programs. On the other hand, it’s hard to justify shorting the market at a time when global growth is picking up and there’s no sign of a rise in defaults.
Money managers are responding to the conundrum in a variety of ways. Morgan Stanley Wealth Management and Deutsche Asset Management have slashed junk exposure. Aberdeen Standard Investments and Schroder Investment Management Ltd. are slowly extricating themselves. Strategists at Bank of America Merrill Lynch simply left a blank space in the credit section of a recent cross-asset strategy report.
“We have been discussing at length internally our overall positioning,” said Ugo Montrucchio, a portfolio manager on the multi-asset team at Schroders in London. “It’s extremely hard to make a value-based case for dropping credit assets even though everyone will tell you that credit looks very expensive.”
A decade of expansionary policies by the world’s central banks has bestowed outsize returns on the $13 trillion market, a trend that continued in the first two weeks of the year. High-yield and investment-grade spreads in the U.S. sank to a post-financial crisis low last week as economic data whetted risk appetite. And corporate credit funds are leading fixed-income ETF inflows again this year, according to Bloomberg Intelligence, after taking in $40 billion in 2017, the most on record.
“Investors are long just about everything because that has been the correct thing to do for the last six or seven years,” said James Athey, a senior investment manager at Aberdeen. “The more successful a strategy has been, the more people are lulled into feeling that this is a one-way bet and you can’t lose.”
Because the secondary market in credit is less liquid than other parts of the market, investors fear that if they sell now, they won’t be able to get back in, according to Athey. And then they also have one eye on the economic data, which are signaling improving global growth and a drop in speculative-grade defaults.
His approach over the past six months has been a compromise: staying overweight credit, but gradually taking chips off the table as spreads tighten. Montrucchio from Schroders has been pursuing a similar strategy, but he’s also been shifting more funds into junk bonds to compensate for any loss of return from downsizing the overall holding.
Investors with broader mandates have favored switching from credit to stocks, which capture the growth story with fewer interest-rate risks. That’s an approach advocated by Christian Hille, who heads the multi-asset portfolios at Deutsche Asset Management in Frankfurt and Alberto Gallo, a portfolio manager at Algebris Investments in London, both said in recent interviews.
Others, such as Jeroen Blokland, a portfolio manager at Robeco Nederland BV in Rotterdam, are simply biting the bullet and staying fully invested in credit, not because it offers value, but because it’s a better option than government bonds ahead of potential interest rate rises.
“It’s one of those things that everyone thinks is expensive but everyone keeps on buying,” said Montrucchio from Schroders. “We consider a market that is already expensive to be liable to becoming even more so going forward.”
To contact the reporters on this story: Natasha Doff in Moscow at ndoff@bloomberg.net, Sid Verma in London at sverma100@bloomberg.net.
To contact the editors responsible for this story: Samuel Potter at spotter33@bloomberg.net, Cecile Gutscher, Alex Nicholson
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