Credit investing for today’s evolving markets
Headwinds call for choosing credit solutions with rigorous research.
June 2024, From the Field -
June 2024, From the Field -
Credit markets have the flexibility to support a range of investor goals and risk tolerances. But given the current climate of a soft macro environment and the rising cost of financing, some investors may be apprehensive. To help instill confidence, investors should consider solutions that emphasize deep fundamental credit research. This should help to uncover inefficiencies, manage risks, and confidently navigate uncertain markets.
In this third and final piece of our series on credit markets, we are delving into the characteristics of the solutions and how they can align with different investment objectives—including lower volatility, generating higher yield, and capital appreciation.
As of April 30, 2024.
For illustrative purposes only. This is not to be construed as investment advice or a recommendationto buy or sell any security.
Source: T. Rowe Price.
As of April 30, 2024.
For illustrative purposes only. This is not to be construed to be investment advice or a recommendation to take any particular investment action.Investments involve risks, including possible loss of principal. Diversification cannot assure a profit or protect against loss in a declining market.
Source: T. Rowe Price.
Investment‑grade corporate bond markets offer a potential combination of consistent income and high‑quality duration. As of the end of March 2024, the average yield in global investment‑grade corporate bonds was around 4.88%—which is well above the average level of 2.94% observed in the last decade.1 This is competitive in absolute terms and relative terms as it offers a yield pickup over traditional government bonds. Compared with other credit segments, yields in investment‑grade corporate bonds are typically lower, however. This reflects lower risk, as companies in this space have a minimum credit rating of BBB‑.2 In all, the attributes of this credit sector suit an investor seeking stable income but with a lower tolerance for risk.
Within investment‑grade credit, investors can target a particular region, such as the U.S. or Europe, or cast the net wider with a global investment‑grade approach.3 For investors looking for a sustainability lens, impact bonds are issued by companies and governments to help finance projects seeking to generate positive environmental and/or social impact alongside a financial return.
A long‑term allocation to high yield offers potential income generation from higher coupons and higher distributing yields. The main source of total return in the high yield bond market is from coupon payments, and current levels are attractive particularly if the fundamental environment remains supportive. As of the end of March 2024, the average yield in global high yield corporate bonds was around 7.63%—which is near multiyear highs.4 That said, the risks are higher than investment‑grade bonds, so investors need to balance the higher yield on offer with their tolerance for risk. Defaults are currently low but expected to rise this year, so individual credit research is essential to help identify companies with elevated risks.
Similar to investment grade, there are options to focus on a particular region’s high yield attributes, including the mature U.S. market. Alternatively, there is Europe. Here the market is younger, with potentially greater opportunities for price and information discovery through prudent research and active management. Global approaches are another option to pursue the attractive high yield opportunities worldwide.
Emerging markets (EM) debt offers attractive return potential and growth opportunities. This multi‑trillion‑dollar market covers more than 700 companies, 80 countries, and 30 currencies. It is vast, with potential to diversify opportunities uncorrelated to the global cycle.
Progress on bringing down inflation means EM central banks are leading developed markets in this turn of the interest rate cycle. There have already been a number of interest rate cuts in EM this year. In all, EM currently offers an attractive yield premium over developed markets, but the credit risks are higher and must be actively monitored.
EM corporate bonds are typically the most defensive way for investors to access EM return potential as the average credit rating of companies is BBB‑.5 Meanwhile, EM local debt offers the potential to diversify and invest in different interest rate cycles. EM hard currency sovereign bonds, meanwhile, feature a wide range of markets, including higher‑yielding frontier markets. A flexible EM portfolio, alternatively, can typically invest across the full range of EM debt asset classes.
Securitized credit offers the potential for competitive yields and is typically less sensitive to interest rate changes due to its generally shorter‑duration profile when compared with sovereign or corporate bonds. Securitization is a process in which cash flow‑producing financial assets—such as mortgages, auto loans, or credit cards—are pooled and repackaged. The resulting securities are sold to investors.
The universe of securitized credit is vast, ranging from commercial mortgage‑backed securities (CMBS) that are backed by loans on assets such as shopping malls, office buildings, and warehouses to asset‑backed securities (ABS) that are backed largely by consumer credit, including credit cards, student loans, and auto loans. Securitized credits also span the credit rating segment. The wide‑ranging asset class offers diversification possibilities but also requires careful research. Despite low default rates in aggregate, performance among subsectors and individual credits can have significantly different results.
A multi‑asset credit solution offers the potential for attractive income and diversified returns. Such solutions invest across a variety of credit sectors and can include investment grade, high yield, emerging markets, securitized, and bank loans. This broad reach creates the potential to diversify return sources and mitigate volatility. This can be appealing for those seeking yield and lower volatility compared with risk markets, such as equity.
"…credit markets offer a wide range of opportunities, from generating income to capital appreciation or a combination of the two."
In all, credit markets offer a wide range of opportunities, from generating income to capital appreciation or a combination of the two. It’s vital to choose an approach that prioritizes research, particularly in the current environment of tight credit spreads6 and heightened geopolitical risks. This can help instill confidence in credit investing and empower investors to take potential advantage of the attractive yields that are available.
For definitions of financial terms used in this material please refer to - www.troweprice.com/en/us/glossary
Kenneth A. Orchard
Head of International Fixed Income
Kenneth Orchard is head of International Fixed Income. He is portfolio manager for the Global Multi-Sector Bond and Diversified Income Bond Strategies and co-portfolio manager for the International Bond Strategy. Kenneth is a member of the Fixed Income Steering Committee, cochair of the fixed income Sector Strategy Advisory Group, and a member of the European and UK Asset Allocation Committees. He is a vice president of T. Rowe Price Group, Inc., and T. Rowe Price International Ltd.
Non-U.S. bonds currently offer higher yields on a currency-hedged basis
1As of March 31, 2024. Yield to worst of the Bloomberg Global Aggregate – Corporate Bond Index. Average is daily average over the period. Source: Bloomberg Finance L.P. Past performance is not a reliable indicator of future performance.
2Credit ratings for securities are typically provided by Moody’s, Standard & Poor’s, and/or Fitch and are referenced here using the Standard & Poor’s nomenclature. A rating of AAA represents the highest‑rated securities, and a rating of D represents the lowest‑rated securities. A rating of BBB- represents the lowest investment grade credit rating. If a rating is not available, the security is classified as Not Rated. In addition to the ratings from the major rating agencies, T. Rowe Price maintains its own proprietary credit rating methodology for all securities held in portfolios
3International investing involves more risk than U.S. investments due to different market structures, among other differences.
4As of March 31, 2024. Yield to worst of the ICE BofA Global High Yield Index. Average is daily average over the period. Source: ICE BofA. See Additional Disclosures. Past performance is not a reliable indicator of future performance.
5As of March 31, 2024. The average credit rating is for the J.P. Morgan Corporate Emerging Markets Bond Index (CEMBI) Broad Diversified. Source: J.P. Morgan. See Additional Disclosures. See footnote 2 for additional details on credit ratings.
6Credit spreads measure the additional yield that investors demand for holding a bond with credit risk over a similar‑maturity, high‑quality government security.
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Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. Fixed‑income securities are subject to credit risk, liquidity risk, call risk, and interest‑rate risk. As interest rates rise, bond prices generally fall. Investments in high‑yield bonds involve greater risk of price volatility, illiquidity, and default than higher‑rated debt securities. International investments can be riskier than U.S. investments due to the adverse effects of currency exchange rates, differences in market structure and liquidity, as well as specific country, regional, and economic developments. The risks of international investing are heightened for investments in emerging market and frontier market countries. Emerging and frontier market countries tend to have economic structures that are less diverse and mature, and political systems that are less stable, than those of developed market countries. Mortgage‑backed securities are subject to credit risk, interest‑rate risk, prepayment risk, and extension risk. There is no assurance that a positive environmental or social outcome will be achieved when investing in impact bonds. Derivatives that may be used in multi‑asset credit solutions may be riskier or more volatile than other types of investments because they are generally more sensitive to changes in market or economic conditions; risks include currency risk, leverage risk, liquidity risk, index risk, pricing risk, and counterparty risk. Diversification cannot assure a profit or protect against loss. All charts and tables are shown for illustrative purposes only.
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