2023 Outlook: Public & Private Credit
In this roundtable discussion, our credit market experts across public and private markets describe how they’re navigating today’s more challenging backdrop and where they’re turning to find strong, risk-adjusted returns.
Scott, as it relates to high yield, do today's market valuations foreshadow what you believe to be a wave of defaults and credit losses—why or why not?
Scott Roth: While fundamental headwinds are clearly building, we believe any potential rise in defaults may be far less significant than what markets are currently pricing in.1 In recent weeks, as an example, the implied default rate for the leveraged loan market has hovered around 6%—that’s a lot of bad news priced in. While defaults will likely increase going forward, we believe they may end up being much lower, perhaps closer to 3%, for a few reasons:
For one, after capital markets reopened in 2020, the bond and loan markets experienced a record amount of refinancing volume—by some estimates, north of a trillion dollars.2 This has resulted in a much more manageable maturity schedule for companies, with only about 8% of the market expected to mature over the next two years. Additionally, the quality of the market has improved notably over the last decade, particularly on the bond side. BBs now account for 53% of the global high yield bond market, for instance, up from 38% in 2007; in the same period, the percentage of single-Bs has dropped to 36%. The European high yield market is even higher-quality—nearly 70% is BB, while only 5% is CCC.3
Interestingly, despite the higher quality of the European market, spreads in Europe are trading roughly 100 basis points (bps) wider than they are in the U.S. given the greater macro risks that exist. The dispersion in yields between the two markets is also as wide as it’s been in recent history, with the U.S. bond market currently yielding roughly 9% and the European market, hedged to U.S. dollars, yielding closer to 11%. This dynamic has created interesting opportunities in so-called “reverse Yankees,” or Euro-denominated bonds issued by U.S. companies—essentially, opportunities have emerged to sell U.S. dollar-denominated bonds of a global issuer, and then buy the exact same bonds, issued in Euros or Pounds, from the same issuer at wider spreads and higher U.S. dollar hedged equivalent yields. The fact that prices in the European market are also more steeply discounted versus the U.S., and given that it’s about one year shorter in duration, also has interesting implications in terms of total return potential going forward.
1. Based on Barings’ market observations.
2. Source: Pitchbook LCD. As of October 31, 2022.
3. Source: Bank of America. As of October 31, 2022.