Close Up: Finding value where others fear to tread

May 31, 2024

Portfolio manager Ian Horn discusses the latest developments, themes and opportunities in the investment-grade and high-yield markets.

Widening EUR single-B spread premium is hard to ignore

The compression of risk premia in credit spreads has been a recurring market theme for several months.

More recently, however, single Bs have decompressed from BB-rated credit as investors have sought to avoid idiosyncratic credit risk and stressed situations (Figure 1).

This could present opportunities for investors able to identify creditworthy single-B names that have underperformed in spread terms. In our view, the market’s recent quality bias has removed much of the value in the BB market. In terms of spread compression from here, single Bs look more interesting for the second half of the year.

Opportunities in fallen angels?

Spread tightening on bonds issued by fallen angels has also lagged over the last 12 months (Figure 2).

Based on our analysis, this is partly due to a small number of issuers facing potential restructuring - such as in the real estate and diversified financial sectors - rather than simply a manageable deterioration in their credit profile and rating.

In a similar vein to the single-B story, investors have shunned these difficult credit calls, but in this case due to uncertainty around ratings and outlooks.

We believe this presents opportunities for investors to find value in issuers that have seen their ratings cut but remain operationally sound and creditworthy.

Short-dated spreads outperforming

A lack of longer-dated issuance and demand for duration has squeezed longer-dated spreads since mid-2022.

Investors focused on yield, rather than spread, have sought to lock-in longer-dated yields at a time of limited new issuance in this part of the market (Figure 3).

However, over the last month or so, longer-dated European investment grade issuance has increased while there has been less short-dated issuance. This has resulted in a reversal of the recent trend and helped shorter-dated spreads outperform (Figure 4).

We anticipate this theme will persist and continue to see better spread value in shorter-dated bonds.

"In European IG, an increase in longer-dated issuance and less supply at the short end has helped short-dated bonds outperform"

Ian Horn

 

 

 

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co are as of May 2024 and may change without notice.

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Index Descriptions

HE10 – The ICE BofA ML BB Euro High Yield Index is a subset of the ICE BofA ML Euro High Yield Index (HE00) including all securities rated BB1 through BB3, inclusive.

ER40 – The ICE BofA ML BBB Euro Corporate Index is a subset of the ICE BofA ML Euro Corporate Index (ER00) including all securities rated BBB1 through BBB3, inclusive.

HE10 – The ICE BofA ML BB Euro High Yield Index is a subset of the ICE BofA ML Euro High Yield Index (HE00) including all securities rated BB1 through BB3, inclusive.

ER09 - ICE BofA 10+ Year Euro Corporate Index is a subset of ICE BofA Euro Corporate Index including all securities with a remaining term to final maturity greater than or equal to 10 years.

HEFA - ICE BofA Euro Fallen Angel High Yield Index is a subset of ICE BofA Euro High Yield Index including securities that were rated investment grade at the point of issuance.

ER05 - ICE BofA 1-10 Year Euro Corporate Index is a subset of ICE BofA Euro Corporate Index including all securities with a remaining term to final maturity less than 10 years.

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