Managers' views

What are the income opportunities available in credit?

Patrick Vogel

Patrick Vogel

Head of Credit Europe

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Julien Houdain

Deputy Head of Credit Europe

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Generating returns from income looks set to remain challenging for investors. Government bond yields are expected to remain low for some time given the scale of monetary and fiscal stimulus being implemented across the world. Equity dividends are being cut, as company revenues and earnings decline, or because central banks or governments require this in order to extend certain loan arrangements.

The challenge facing income investors

With little income on offer in the government bond or equity markets, it seems inevitable investors will increasingly look to the credit market for opportunities. We believe there’s currently a window of opportunity for investors given historically high corporate bond spreads, which underlines the attractiveness of yields in credit compared to other markets.

What about defaults?

While the return prospects are attractive, there is nevertheless the likelihood that defaults will rise given the stress in the market. This increased and very real risk is part of the reason yields have risen so much. We believe, however, that the rate of defaults implied by market levels has gone too far.

The historical average five-year default rate for global IG has been 0.9%; based on the current level of spreads, US IG now has an implied default rate of 8.7%. For the HY market, the historic average default rate is 14.6% compared to a currently implied 37%.

Which areas look attractive?

While we expect a decline in global GDP by 3%, there will still be winners in this crisis situation.

The importance of telecommunication services has increased significantly. With the rising number of people working from home, demand for broadband services has risen and we’ve seen a number of telecommunication businesses become more profitable.

One might expect reduced power demand from the industrial sector to have a negative impact on utility companies, but power demand from the private and residential sector, which pay higher prices, is up. Also, power companies’ revenues are no longer solely linked to power volumes; they are also linked to service contracts. So for the most part, we expect revenues for utilities will be relatively stable.

Then there are the more vulnerable companies who have had to effectively hibernate, in some cases halving or virtually wiping out revenues. There are numerous companies within the leisure, hotels, airlines and transportation sectors struggling to cover their operating costs. As these companies start to run out of liquidity, they will have to turn to central banks, government programmes or the financial markets. We have seen some instances already of businesses in these areas, some of high quality, with strong underlying operations and sizable assets, issuing new bonds with very attractive yields.  

Window of opportunity

The income opportunity set in global credit has expanded significantly over the past few weeks. Credit spreads are at historic highs, offering yields that neither the equity market nor the government bond market can match. In the past, these levels have preceded attractive returns, but we think investors probably have a relatively short window of opportunity to take advantage of these dislocations in the market.


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