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Public Fixed Income

IG Credit: Finding Value in Less Conventional Places

January 2024 – 2 min read

While spreads have tightened, investment grade credit continues to offer compelling total return potential as well as many idiosyncratic opportunities.

Investment grade (IG) credit looks poised to perform well this year due to a greater likelihood of interest rate cuts and issuers that have prepared for the possibility of a more challenging operating environment. Continuing the pattern seen since mid-2023, IG spreads tightened in the fourth quarter, from 121 basis points (bps) at the end of September to 99 bps as 2023 drew to a close. That is well below the 10-year average of 124 bps and significantly below the 20-year average of 149 bps—but, tight spreads don’t necessarily mean a lack of opportunity (Figure 1).

Figure 1: IG Spreads Continue to Grind Tighter

ig-finding-value-chart1.jpgSource: Bloomberg Barclays. As of December 31, 2023.

Softening Fundamentals, Strong Technicals

Corporate fundamentals remain positive overall, despite some recent softening. With warning flags of a recession flying for more than a year, many IG issuers have been preparing for tougher times through cuts in capex spending and by locking in long-term debt at the ultra-low rates that prevailed before the U.S. Federal Reserve began its tightening cycle. Nevertheless, interest coverage has started to decline as issuers coming to market recently have had to bear greater interest expense. While companies generally have found that customers are willing to absorb some inflation-driven higher prices, rising costs have become a headwind for margins—although recent margin declines largely represent a return to more normal profile levels following an unusual spike in margins during the Covid lockdowns. Revenue was down a slight 0.6% year-over-year, while EBITDA contracted by 6.6%, the largest year-over-year decline since the third quarter of 2016.1 Management teams seem to be reacting to slowing growth with more conservative management of balance sheets, as evidenced by the 11.1% year-over-year decline in shareholder returns.2  

Going forward, favorable technical factors are likely to outweigh some of the fundamental weakening. The appeal of higher yields should result in inflows continuing to exceed outflows, as has been the case in recent months. In addition, the outlook for new supply in 2024 is a relatively flat $1.2 trillion. Should economic or policy shocks occur, the IG market’s greater liquidity relative to other credit asset classes should allow for portfolio repositioning that can help dampen volatility. Two technical indicators likely to be plateauing in coming quarters are the number of rising stars versus fallen angels and the number of credit-rating upgrades versus downgrades, each reflecting the greater difficulty issuers will face in improving credit quality from current high levels.

Idiosyncratic Opportunities

Although spread tightening in the IG asset class is a reality, so too is wide dispersion. As a result, we see current opportunities in particular industries and in certain situations. From a sector perspective, we are finding compelling opportunities in financials, especially insurance companies and large U.S. banks, as well as in Yankee bonds of large foreign banks, which are cheaply priced on an historical basis. In addition, select real estate investment trusts specializing in areas other than offices are offering value. We also are finding select opportunities in telecom and utilities, and remain positive on energy, where M&A activity has remained credit friendly. Our caution on pharma and tech continues.

“Many of the most interesting opportunities in the market today are of a more idiosyncratic or catalyst-driven nature.”

Many of the most interesting opportunities in the market today are of a more idiosyncratic or catalyst-driven nature. For instance, we have seen an uptick in equity-financed acquisitions, particularly in the insurance sector, in which a higher-rated company acquires a lower-rated issuer. Research into IG-rated sub securities and hybrid securities has led to investments in shorter-duration securities that we believe have a high probability of being called over the next two years, such as select AT1s and preferreds.  

Looking Ahead

Given their still-strong financial condition and competitive advantages, IG companies tend to be fairly well-positioned to weather whatever economic difficulties may lie ahead. These fundamental advantages, as well as positive technical factors, point to continued opportunities for investors. That said, given the current phase of the economic and market cycle, those opportunities more often exist in idiosyncratic corners of the market—underscoring the importance of in-depth research capabilities, bottom-up credit selection, and long-term sector experience.

1. Source: J.P. Morgan. As of December 31, 2023.
2. Source: J.P. Morgan. As of December 31, 2023.

Charles Sanford

Head of Investment Grade Credit

Stephen Ehrenberg

CFA, Managing Director

The document is for informational purposes only and is not an offer or solicitation for the purchase or sale of any financial instrument or service. The material herein was prepared without any consideration of the investment objectives, financial situation or particular needs of anyone who may receive it. This document is not, and must not be treated as, investment advice, investment recommendations, or investment research.

In making an investment decision, prospective investors must rely on their own examination of the merits and risks involved and before making any investment decision, it is recommended that prospective investors seek independent investment, legal, tax, accounting or other professional advice as appropriate.

Unless otherwise mentioned, the views contained in this document are those of Barings. These views are made in good faith in relation to the facts known at the time of preparation and are subject to change without notice. Parts of this document may be based on information received from sources we believe to be reliable. Although every effort is taken to ensure that the information contained in this document is accurate, Barings makes no representation or warranty, express or implied, regarding the accuracy, completeness or adequacy of the information.

Any forecasts in this document are based upon Barings opinion of the market at the date of preparation and are subject to change without notice, dependent upon many factors. Any prediction, projection or forecast is not necessarily indicative of the future or likely performance. Any investment results, portfolio compositions and/or examples set forth in this document are provided for illustrative purposes only and are not indicative of any future investment results, future portfolio composition or investments. The composition, size of, and risks associated with an investment may differ substantially from any examples set forth in this document. No representation is made that an investment will be profitable or will not incur losses. Where appropriate, changes in the currency exchange rates may affect the value of investments.

Investment involves risks. Past performance is not a guide to future performance. Investors should not only base on this document alone to make investment decision.

This document is issued by Baring Asset Management (Asia) Limited. It has not been reviewed by the Securities and Futures Commission of Hong Kong.

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