Janus Henderson has declared that parts of the Australian credit market remain “alive and well” in spite of the rising rate environment.
Shan Kwee, a portfolio manager on the firm’s Australian fixed interest team, suggested in a recent note that opportunities still exist in credit markets for those who know where to look.
“Our approach in these market conditions is to keep powder dry for when markets hit rough patches to capitalise on buying opportunities when quality goes on sale,” he explained.
“Through various cycles, we have observed that valuations overshoot fundamental fair value in periods of heightened uncertainty or acute needs for liquidity. One such example being the recent liquidation of assets from UK pension funds.”
Mr Kwee stated that, amid slowing growth, high rates and tighter liquidity, the risk of wealth destruction and the potential for permanent capital losses in the form of defaults is magnified.
“Like buildings in a storm, those with solid fundamentals are far more likely to survive, while the less solid, riskier and illiquid companies are more prone to feeling the severe pinch of more discerning capital allocation,” he said.
According to Mr Kwee, a silver lining of higher rates is that the yield available from the highest quality and most liquid parts of fixed income markets now offer attractive levels of income.
However, he noted that the commitment to tackle high inflation through tightening global liquidity is set to continue driving volatility in credit markets moving forward.
“To navigate the environment ahead, investors should look for improved compensation for risk,” Mr Kwee said.
“We observed that the repricing across different pockets of credit and risk premia have not been simultaneous, providing outperformance opportunities through active rotation.”
Janus Henderson said that the more illiquid, structured, and levered sectors of the market have yet to adequately reprice, which it expects will occur as earnings outlooks weaken.
“We anticipate that as conditions tighten further, global spreads will suffer decompression, where high-quality liquid credit outperforms lower quality as compensation for default risk and illiquidity needs to increase,” said Mr Kwee.
“In our view, a focus on mitigating downside tail risk, mismatches in underlying liquidity, and bottom-up understanding of security complexity will produce a more robust portfolio.”
Jon Bragg
Jon Bragg is a journalist for Momentum Media's Investor Daily, nestegg and ifa. He enjoys writing about a wide variety of financial topics and issues and exploring the many implications they have on all aspects of life.
