About credit investment
Fixed income is generally considered as a relatively stable and dependable investment tool. Investing in the debt of companies, also called credit fixed income, can offer benefits. However, "credit" is a wide-ranging area. Before investing in this market, challenge yourself to see how much you know about credit investment by going thru the different levels of questions below: Level 1 > Level 2 > Level 3
Level 1: Is credit different from equity?
When comparing credit to equity, equity has the lowest seniority in the payout order. To compensate for this additional risk, equity holders require a higher return on capital. Reflecting the higher risk, equity markets are relatively more volatile than credit market.
Various debt obligations can have different priority of payment corresponding to the seniority rankings. Senior secured debt top the ranking structure in the case of a default, with owners being paid off before other debtors.
Level 1: What is a corporate credit rating?
A credit rating is an evaluation of the creditworthiness of a borrower with respect to a particular debt or financial obligation assigned by external rating agencies. Moody’s, Standard & Poor’s and Fitch Ratings are three top agencies deal in credit ratings. Each credit rating agency has defined its own credit rating, the ratings generally lie on a spectrum ranging from the highest credit quality AAA on one end to default on the other. BBB- is the lowest rating of investment grade, while ratings below BBB- are considered as high yield.
Level 2: Benefits and challenges of investing in credit
Investors purchase bonds for several reasons: growth, income, liabilities matching, capital preservation and to reduce volatility. However, investors need to be aware of the two main risks involved:
- Corporate bonds generally carry a higher default risk than government bonds issued by developed countries. Defaults of underlying bond investments can reduce portfolio returns substantially. Active managers can employ rigorous credit research to maximize income without increasing potential risk significantly.
- Interest rate risk affects credit investing. When interest rates rise, bond prices generally fall.
Level 2: What is a credit spread?
A credit spread is the difference in yield between a credit instrument and a government bond of similar maturity. It is the risk premium charged by credit investors, for taking additional risk (liquidity risk, default risk, political risk and so on) of investing in a credit instrument.
Creditspread = the yield on corporate bonds - the yield on government bonds
The 4 characteristics of credit spreads:
- Measured in basis points (bps), with a 1% difference in yield equal to a spread of 100 basis points.
- Vary from one security to another based on the credit quality of the bond issuer.
- The higher the credit spread, the greater the risk level of the issuer is, and vice versa.
- General speaking, credit spreads fluctuations are commonly due to changes in economic conditions.
Level 3: What is affecting credit performance?
Credit spreads are a good barometer of credit market. Widening credit spreads indicate growing concern about the ability of corporate to service their debt while corporate bond prices fall and yields rise. Conversely, narrowing credit spreads indicate improving private creditworthiness. Corporate bond prices rise and yields fall. A number of factors affect credit spreads:
Idiosyncratic risk
Risk factors endemic to particular company or sector has an important impact on credit spreads over time. The impact could be mitigated by improving company fundamentals.
Economic growth
In economic expansion stage, earnings of most companies grow. This translates to a higher ability to repay debt, assuming debt levels stay constant. Default risk decreases, resulting in the narrowing of credit spreads. While the inverse happens in economic slowdown.
Economic cycle
Credit tends to perform in a more normalized framework during stages of stabilization and acceleration and could bear a higher default risk during stages of deceleration and slowdown.
Schroder ISF Global Credit Income
Blending the right mix for changing investment climates
Schroder International Selection Fund is referred to as Schroder ISF.
The fund has environmental and/or social characteristics within the meaning of Article 8 of Regulation (EU) 2019/2088 on Sustainability-related Disclosures in the Financial Services Sector (the “SFDR”).
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