• David Lebovitz, Global Market Strategist at JPM Asset Management, and Jonathan Seagull, Co-CIO at High Bridge Capital Management, discusses private and public credit market trends in a low yield environment.
• Negative yielding debt currently stands at $13trn, this is predominantly government bonds but there is an increasing amount of negative yielding corporate credit.
• Higher investment return targets have led investors to enter higher quality liquid parts of high yield market (BB) and avoid less liquid CCC issues.
• Investors are more active outside of traditional public credit markets. Private credit markets have doubled in size since the financial crisis and investors are entering deals at every worsening terms in search for yields.
• Abundant liquidity has incentivised borrower-friendly behaviour like add backs, Earnings (EBITDA) adjustments, covenant light issuance and sponsored back lending.
• Seagull explains that such behaviour is emblematic of late-cycle dynamics. We are witnessing coupon compression, covenant erosion and weaker underwriting requirements in traditional direct and mezzanine lending. Covenant light loans in institutional leverage lending in the US has reached 80% in 2018 and has increased every year since the crisis.
• Long only funds focus on IG and large HY issues and cannot invest in companies excluded from the Index. This creates opportunities for niche players.
Why does this matter? The hunt for yield provides opportunities as well as risks. Greece has issued 3-month debt at negative yields (and recently 10-year debt at sub 1%) despite debt/GDP one of the highest in the world at around 175% and huge remaining challenges to reform its economy. Argentina’s sovereign debt is now subject to restructuring following a very sharp run up in fx-denominated debt in just a few years. For both corporates and sovereigns investors must determine where there is still value in credit.
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