Lack of dispersion supports ‘up-in-quality’ bias

July 9, 2024

Portfolio manager Ian Horn looks at what investors can learn from comparing mean and median credit spreads, and explains why current market conditions favour quality over beta.

An investor recently asked me whether it is useful to consider mean and median spreads when looking at credit valuations. The chart and comments that follow are a response to that question and highlight a theme we have discussed a lot recently.

Specifically, credit spreads in European investment grade have remained wide of their historic levels, but spread premia ­― how much more you get paid for additional risk ― are compressed.

Comparing mean and median spreads is a useful way to show relative levels of dispersion in the market. When dispersion is lower, spreads will be closer to a normal distribution. In such an environment, mean and median spreads will be similar.

However, when we have a fatter / longer tail of wider spreads ― which is what typically happens when dispersion is higher ― then the gap between the mean and the median will widen (the mean will be pulled higher by the wider data points).

Figure 1 is a plot of mean and median spreads over the last 14 quarters for European BBBs.

Figure 1 shows the exact point we’ve been trying to articulate. Broad BBB spreads are still wide of their pre-Federal Reserve and European Central Bank rate-hiking levels, and perhaps will stay here to reflect the recent uptick in political uncertainty. However, dispersion ― as measured by the difference between mean and median spreads ― has returned to pre-central bank hiking levels.

The conclusion, we would argue, is that whilst credit remains relatively attractive from a spread and yield perspective, investors should be cautious of reaching into the higher-beta parts of the market when spread premia are compressed. For our global strategies, we generally prefer US credit currently, but within our European allocations, we are gradually expressing an ‘up-in quality’ theme whilst staying fully invested.

 

“While credit remains relatively attractive, investors should be cautious of reaching into the higher-beta parts of the market when spread premia are compressed.” 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 July 2024 and may change without notice.

-----------

Index Descriptions

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.

Important Information

Muzinich and/or Muzinich & Co. referenced herein is defined as Muzinich & Co., Inc. and its affiliates. Muzinich views and opinions.  This material has been produced for information purposes only and as such the views contained herein are not to be taken as investment advice. Opinions are as of date of publication and are subject to change without reference or notification to you. Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy. The value of investments and the income from them may fall as well as rise and is not guaranteed and investors may not get back the full amount invested. Rates of exchange may cause the value of investments to rise or fall.

Any research in this document has been obtained and may have been acted on by Muzinich for its own purpose. The results of such research are being made available for information purposes and no assurances are made as to their accuracy. Opinions and statements of financial market trends that are based on market conditions constitute our judgment and this judgment may prove to be wrong. The views and opinions expressed should not be construed as an offer to buy or sell or invitation to engage in any investment activity, they are for information purposes only.

This discussion material contains forward-looking statements, which give current expectations of future activities and future performance. Any or all forward-looking statements in this material may turn out to be incorrect. They can be affected by inaccurate assumptions or by known or unknown risks and uncertainties. Although the assumptions underlying the forward-looking statements contained herein are believed to be reasonable, any of the assumptions could be inaccurate and, therefore, there can be no assurances that the forward-looking statements included in this discussion material will   prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation that the objectives and plans discussed herein will be achieved. Further, no person undertakes any obligation to revise such forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

United States: This material is for Institutional Investor use only – not for retail distribution. Muzinich & Co., Inc. is a registered investment adviser with the Securities and Exchange Commission (SEC). Muzinich & Co., Inc.’s being a Registered Investment Adviser with the SEC in no way shall imply a certain level of skill or training or any authorization or approval by the SEC.

Issued in the European Union by Muzinich & Co. (Ireland) Limited, which is authorized and regulated by the Central Bank of Ireland. Registered in Ireland, Company Registration No. 307511. Registered address: 32 Molesworth Street, Dublin 2, D02 Y512, Ireland. Issued in Switzerland by Muzinich & Co. (Switzerland) AG. Registered in Switzerland No. CHE-389.422.108. Registered address: Tödistrasse 5, 8002 Zurich, Switzerland. Issued in Singapore and Hong Kong by Muzinich & Co. (Singapore) Pte. Limited, which is licensed and regulated by the Monetary Authority of Singapore. Registered in Singapore No. 201624477K. Registered address: 6 Battery Road, #26-05, Singapore, 049909. Issued in all other jurisdictions (excluding the U.S.) by Muzinich & Co. Limited. which is authorized and regulated by the Financial Conduct Authority. Registered in England and Wales No. 3852444. Registered address: 8 Hanover Street, London W1S 1YQ, United Kingdom. 2024-07-08-13977