Corporate Credit Outlook 2021 - A Brighter Future That Comes With A Price December 2020 - Muzinich & Co.
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Corporate Credit Outlook 2021 A Brighter Future That Comes With A Price December 2020 A brighter economic future is reasonably expected in 2021, but active and smart management will be required to navigate credit markets with tighter valuations. 1
Key Takeaways
Credit – Further compression and the hunt for yield w ith strong technicals in 2021
• The big r eset in economic pr ospects should tr igger deep por tfolio r e-balancing, with accumulated cash put
to wor k in ear ly 2021
• The sear ch for yield will likely dominate the cr edit asset allocation, as the ultr a-low r ates envir onment
continues, suppor ting fur ther spr ead compr ession amid excess liquidity channelled into cr edit mar kets
• High yielding mar kets should benefit fr om better cyclical pr ospects and lower default/loss r isks
• We see main oppor tunities in emer ging mar kets cor por ate bonds, global high yield bonds, and lever aged
loans in a car r y focused investment str ategy
• We favour Eur o investment gr ade over US investment gr ade on a r elative basis due to Eur opean Centr al Bank
suppor t and r eduction in bond supply
Erick Muller,
• We ar e car efully r otating global por tfolios to ‘r eopening’ sector s in global cr edit, such as autos and ener gy, Director of Product
with attention to the individual balance sheet’s str engths and weaknesses and Investment
Macroeconomic Environment - A brighter future requiring further fiscal and monetary support Strategy
Er ick joined Muzinich in 2015.
• Recover y will likely r emain uneven in 2021 and fiscal policies ar e unlikely to shift to auster ity soon.
His r esponsibilities cover
Continued suppor t fr om monetar y policies will be needed to pr event unwar r anted financial conditions macr o and fixed income
tightening, and to help maintain the cost of ser vicing debt at affor dable levels mar kets strategy and product
management, as well as client
• With per sistent low levels of inflation in developed economies, shor t r ates ar e “pinned” and changes in the r elationships across
economic outlook will r eflect on the steepness of yield cur ves institutions, global
distr ibution platforms and
• Emer ging economies’ r ecover y, suppor ted by a dynamic expor t sector and a tr anslation into domestic
global pr ivate banks. Erick
demand, is well under way, especially in China. The commodity pr ices’ bullish cycle should benefit Latin joined Muzinich from JP
Amer ica Mor gan AM, w here he spent
near ly four years as a Senior
Client Por tfolio Manager. Prior
Fundamentals – Further improvement in 2021 w ith earnings growth but still highly liquid balance sheets to that he spent over four
year s as Head of Fixed Income
• We see impr oving fundamentals tr end to likely continue in 2021 fr om 1H20 lows Pr oduct Management at
Fidelity Worldwide Investment
• We expect per sistent ear nings gr owth to pr ogr essively r educe lever age fr om elevated levels in 2020. and befor e that was Global
Cor por ates may want to keep high liquidity on the balance sheet as a cheap insur ance policy, in case the Head of Capital Mar ket
economic r ecover y disappoints expectations Resear ch at Crédit Agricole
CIB for eight years. Erick
• We keep a constr uctive view on fallen angels for 2021, both in USD and Eur o mar kets star ted his career in finance
as a Eur opean economist at SG
War burg in France. He then
w or ked as a Senior Economist
Technicals – The big rotation from cash to a search for yield, and low er supply at HSBC and UBS w ith a
par ticular focus on the
• Less gr oss issuance and investor s with a higher r isk appetite, could help to fur ther compr ess cr edit spr eads
Eur ozone preparation and
in 2021
cr eation. Erick has an MBA in
• High yielding assets ar e set to benefit amid impr ovement of economic pr ospects, and lower default r isks Finance – Mar keting from the
ESLSCA Business School and a
• We expect the Eur opean Centr al Bank to continue to pur chase cor por ate bonds, r educing bond supply r isk degr ee in Economics from the
fr om non-financial investment gr ade issuer s Université Panthéon Assas.
Valuations – From tight to … tighter
• Total r etur n pr ospects for investment gr ade (IG) will likely be closely linked to yields’ dir ection given tight
spr ead situation, mor e so in the US
• Fur ther compr ession of spr eads differ ential between high yield (HY) and IG is expected, with B-r ated
companies to per for m fur ther , befor e being consider ed too r ich
• The emer ging mar ket pr emium has r emained elevated in 2020 which pr esents an oppor tunity to impr ove
spr eads and yields in 2021
• Lever aged loans could offer higher car r y and better convexity potential than bonds. We also expect
r enewed demand fr om US r etail investor s for US lever aged loans. Both Eur o and US mar kets should benefit
fr om higher activity in Collater alised Loan Obligation (CLO) pr inting in 2021.
2The attempt to for ecast futur e mar ket r etur ns often appear s futile, As a r esult sover eign, and sometimes cor por ate, debt levels r eached
but it was all the mor e so this year . The magnitude of the due to the pandemic episode ar e likely to test the ner ves of
pandemic, the sever ity of the economic shock, and the speed of the investor s, and we cannot think about the futur e without
financial dislocation in the fir st quar ter of 2020 wer e incor por ating r isk of cr edibility loss and solvency accident,
unpr ecedented and bar ely imaginable. And yet, as the vir us par ticular ly in those ar eas most hit by the Covid-19 cr isis. However ,
outbr eak continues to expand this winter , in most ar eas of the we appr ehend this r isk mor e in idiosyncr atic ter ms than systemic
globe, all major cor por ate cr edit asset classes ar e set to deliver ter ms.
positive total r etur ns for 2020, likely to be close or super ior to
Fig. 2: G7 Fiscal Deficit unlikely to disappear quickly
r etur ns pr omised by the yield at the end of December 2019.
For ecast
Hopes for a Global Economic Recovery Acceleration
in 2021-2022
The availability and distr ibution of a vaccine against Covid -19 is a
game changer when building the global economic scenar io for 2021-
2022. Ther e ar e still some uncer tainties on the speed of deployment
and the population’s desir e to be inoculated, but over all, the
vaccine availability builds a r obust floor to the economic r ecover y
pr ojections for the next two year s, eventually closing the global
negative output gap gener ated in 2020. The question is whether
per manent damage has been done to the global economy, acting as
a dr ag and slowing the r ecover y, or if most of the economic pain is
r ever sible in full. In such a scenar io, accumulated pr ivate sector Source: IMF Fiscal Monitor, October 2020.
savings being r e-injected into the economy would help to boost Continued suppor t fr om monetar y policies is a necessar y condition
economic gr owth in this catch-up phase, beyond cur r ent gener al in that context. Given the magnitude of the debt accumulation,
expectations. maintaining the cost of ser vice of the debt at minimum levels helps
Fig. 1: Global GDP recovery boosted by vaccines deployment, but to make this extr a debt affor dable. It is likely that policy r ates will
still uneven be kept close to lower bound levels, wher ever this level is for each
Annual Real GDP major r egion, for a ver y long time, and that quantitative easing will
likely be maintained to pr event over all financial conditions fr om
unwar r anted tightening, and r eal yields fr om non-affor dable
6
incr eases. In this context, the r ecent announcements fr om the
Eur opean Centr al Bank (ECB) highlights the shift fr om emer gency
2 actions, wher e over deliver ing helped to stabilise mar kets, to
extending the dur ation of the monetar y cur e to suppor t economic
%
-2 catch-up and r emove potential long-ter m scar s fr om the cr isis.
-6 The Inflation Game Ain’t Over
-10
2019 2020 2021 2022 2023
The pandemic immensely complicated the Centr al Banks’ task of
getting inflation back to tar get. The induced demand shock mor e
USA France Germany than compensated the initial supply side distor tion’s impact on
UK China Euro Area pr ices, and finally exacer bated the inflation misses. Mor eover ,
gr owing the monetar y base at extr aor dinar y pace was facing a
Sour ce: IMF WEO October 2020, World Economic Outlook Database.
par allel dr astic fall in money velocity. As a r esult, the lar gest
economies, including China, ar e now facing an even mor e per sistent
Fiscal and Monetary Response Still Needed, but low level of cor e inflation. With labour mar kets dur ably wounded,
Long-Term Credibility Likely to be Tested inflation-push factor s ar e unlikely to quickly r estor e inflation levels
close to tar gets.
Sustained fiscal suppor t, co-or dinated with monetar y policy, is a
condition of success for per sistent economic r ecover y, in our view.
The lessons lear ned fr om the 2008/09 financial cr isis episode is that
shifting to auster ity measur es too soon after a cr isis alter s the “The availability
r ecover y dynamic. However , the extr aor dinar y emer gency fiscal
r esponse to the economic slump has deter ior ated public finances far
and distribution of a
mor e so than the 2008/09 financial cr isis. Accor ding to the IMF, the vaccine against
fiscal deficit of G7 countr ies will r each 16% of GDP in 2020, x1.6 Covid-19 is a game
times what was r egister ed in 2009. 1 The 2021 expected deficit
accor ding to the IMF is 7.5% but will likely be far super ior in our changer”
view given the cost of lockdowns extension in most wester n
countr ies in 4Q20 and par t of 1Q21.
3The question is whether the vaccine can act to r ever se negative
pr essur es on inflation, allowing the inflation gap to close. When “Forward guidance
obser ving mar ket-based inflation expectations, the impact of
on rates from
vaccine availability boosted long-ter m inflation expectation (see
Fig.3). In the US, 10y br eakeven inflation r ose back to June 2019 Central Banks is
levels, but still below the 2% tar get set by the Feder al Reser ve.
unambiguous: policy
Ger many’s 10y br eakeven also r ose meaningfully since mid-
November but stopped well below 1%. The bullish commodities rates are pinned
pr ice tr end that is likely to go along economic r ecover y may help to
where they are”
par tially close the inflation gap, but sustained suppor t fr om
monetar y policy is the most likely scenar io for the next few year s,
The Steepness of Government Yield Curves to
in or der to achieve such an outcome.
Absorb Inflation Expectations Changes
Fig. 3 Inflation expectations reset w ith vaccines, but Central
Banks targets are still missed
With stable policy r ates, any changes in economic outlook, and their
impact on inflation expectations, will likely be r eflected in the
steepness of the yield cur ve. On the other hand, the Centr al Banks
won’t be r elaxed about any unwar r anted tightening of r eal yields.
Per cent
So, they will ver y likely want to keep some contr ol of the yield
Per cent
cur ve. Ther e is a clear r eluctance to for mally expr ess this that way
- it would bind them too much to financing any fiscal deficit without
contr ol - but keeping the asset pur chase pr ogr amme active and
flexible helps to r each the same r esults while keeping independence
intact. For por tfolio management, ther e is not much to expect fr om
a str ategic long positioning in dur ation as in 2020. In our view, the
dur ation tr ade that helped in 2020 is likely to become much mor e
tactical and oppor tunistic, in a long-ter m envir onment that will see
Source: Macrobond, as of December 11th , 2020.
long yields r ising pr ogr essively, but not without volatility.
Policy Rates are Pinned Close to Zero or Negative
for a Long While Emerging Economies on the Recovery Path
For war d guidance on r ates fr om Centr al Banks is unambiguous:
policy r ates ar e pinned wher e they ar e for a long time. 2 For the China will likely show positive r eal GDP pr ogr ession for 2020, unlike
Feder al Reser ve, the new monetar y policy fr amewor k would r equir e all other lar ge economies. Its “fir st-in-fir st-out” tr ajector y after the
not only inflation expectations to be dur ably anchor ed ar ound pandemic is r emar kable. Its manufactur ing sector has been fully
tar get, but actual inflation should settle above tar get for a good oper ational when other r egions wer e still impair ed by lockdowns,
while (a “make-up” str ategy”) befor e it feels comfor table r aising able to captur e the r estor ation of the global cycle fir st, as soon as
inter est r ates. Its updated r eaction function incor por ates that a low the second quar ter of 2020. Moder ate easing in monetar y policy and
unemployment r ate can be toler ated for some time befor e being tar geted fiscal suppor t wer e enough to manage the activity slump of
followed by any tightening action. In the case of the ECB, while the the fir st half of the year . For this r ecover y to be sustained, a
Str ategic Review conclusions shall be for mally communicated by domestic demand dynamic shall complement the expor t sector
September 2021, it is likely that patience and per sever ance will be dynamism. The r ecent data on PMIs and r etail sales ar e encour aging
r equir ed as well, and that str ong convictions on an inflation upside in this context. We expect some fiscal suppor t to be maintained in
tr end ar e necessar y befor e embar king on a policy r ates 2021 in this dir ection.
nor malisation jour ney, convictions not seen so far in the ECB staff
Fig. 5 Emerging Markets are recovering w ell from the pandemic
economic pr ojections r unning up to 2023. 3
PMI Index
Fig. 4: Policy rates “pinned” for a long time
Per cent
Index
Sour ce: Macr obond, Macrobond IHS Markit PMI, as of November 30 th, 2020.
Sour ce: Macr obond, official policy r ates, Federal Reserve, European Central Any figur e above 50 suggests the economy is expanding, below 50 the
Bank, Bank of England, Muzinich forecasts starts at end of December 2020. economy is contracting.
4In addition, it should help to shift balance sheet management fr om
“The pandemic defence to optimisation in comfor table financials conditions. Back
to the lever age r atio, we r ecognize the cur r ent levels as elevated in
created a double
aggr egate, but ar e not par ticular ly wor r ied or impatient to see it
shock for credit being cut again, for the r easons stated above. As we believe r ating
metrics: earnings agencies have a similar position, they ar e unlikely to downgr ade
cor por ates fr om this angle only. Pr olonging this ar gument, we wer e
destruction with the not over ly concer ned by fallen angels after the 2Q20 wave and keep
need to raise cash” a constr uctive view on the matter for 2021.
Of cour se, such views ar e to be consider ed on aver age and do not
include differ entiation by sector s. While our investment appr oach
After a spectacular shut down in Mar ch, India’s economy has
favour ed “wor k-fr om-home” and defensive sector s for most of the
r ecover ed pr ogr essively, despite the healthcar e challenge. The
fir st half of 2020, the value cr eated in sector s most affected by the
manufactur ing sector r ecover ed ver y str ongly in the thir d quar ter ,
pandemic opened oppor tunities dur ing summer time, and we ar e
while the ser vices sector sur pr ised on the upside.
car efully r otating global por tfolios to ‘r eopening’ sector s in global
The r eflation tr ade is also beneficial to Latin Amer ica. Commodities cr edit, such as autos and ener gy, with attention to the individual
pr ices ar e back into a bullish cycle, which tend to help the r egion’s balance sheet’s str engths and weaknesses.
expor ter s. Impr oving ter ms in oil mar kets should also help the lar ge
The vaccine deployment in 2021 encour ages such r otation to go
state-owned ener gy cor por ations.
fur ther , given the r eduction in cyclical r isks. We ar e however
cognizant of the cur r ent vir us cir culation in developed economies
Fundamentals on the Improving Slope and, the US specifically, r aises shor t-ter m r isks that cannot be
ignor ed and r equir e cautious stock selection and smar t timing.
The sever ity of the pandemic cr eated a double shock for cr edit Fig. 7: Still value in rotation into US HY “reopening” sectors after
metr ics: an immediate ear nings destr uction followed by the need to last few months’ recovery (Hig h-Low-Current Spreads in bps YTD)
r aise cash to pr otect the balance sheet, to substitute for vanished
ear nings. As a r esult, the lever age r atio went up dr amatically whilst
the default r isk also incr eased. Since then, the r esult of Muzinich’s
bottom-up cr edit r esear ch led to a pr ogr essive and r egular upgr ade
of our appr eciation of cor por ate fundamentals on aver age, fr om
ver y low levels in 1Q20 to close to neutr al cur r ently. The r ise in
default r ate outside of the ener gy sector is likely to have peaked in
4Q20, in our view. We believe that this default cycle is not
compar able to that in other cr ises, because the fiscal and monetar y
suppor t has been r emar kable, and efficient in maintaining banks
cr edit flows to cor por ates open, or to allow them to access mar kets
at affor dable pr ices. With economic r ecover y under way, not only Sour ce: Macr obond, ICE Bank of America, High-lows and current spread to
have ear nings lar gely r ever sed the negative lever age r atio tr end, w or st in basis points, between January 1st, 2020 and November 30th, 2020, US
but investor s’ appetite for yields has sustained the demand for new High Yield index (ICE BAML H0A0 index) by sector composition.
issuance cor por ate bonds.
Regar ding emer ging cor por ates, we have str essed sever al times that
Fig. 6: US Default Rates likely to have peaked in 4Q20 emer ging cor por ates enter ed the cr isis with a mor e positive
lever age dynamic than their US or Eur o cor por ate counter par ts. Of
8% 35.00% cour se, they suffer ed a ver y similar ear nings destr uction
7% 30.00% phenomenon, but given the above, less demand on ear nings gr owth
6% 25.00%
is r equir ed in 2021 to compensate for the 2020 extr a lever age.
5%
20.00%
4%
3%
15.00% Technical Factors Should Support Further Spreads
2% 10.00% Compression
1% 5.00%
0% 0.00%
The supply/demand dynamic was ever ything but pr edictable in
Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-20
Par-weighted Default Rate (LHS) 2020. The Covid-19 cr isis pr essur ed cor por ates to r aise
Par-weighted Default Rate ex-Energy (LHS) pr ecautionar y cash, to pr otect fr om r ating downgr ades. In our view
Distressed Ratio (RHS) ther e will be less need for such a move in 2021, but ver y favour able
bor r owing conditions will likely pr evail. Net negative r ating
Sour ce: Bank of Amer ica, High Yield Cr edit Chartbook, as at end of November migr ation fr om IG to HY has been a significant sour ce of supply in
2020. US High Yield par weighted default rate full mar ket and ex -energy,
the HY space. Such net change amounted to US$190 bn in the US
distr essed ratio US High Yield market.
cr edit mar ket in 2020, for an equivalent amount of EUR 60 bn in
Looking for war d, we believe it is unlikely that this pr ecautionar y Eur o cr edit mar ket. It is expected to be much less r emar kable in
cash in the balance sheet disappear s quickly, financing M&A or 2021, with net addition of US$30 bn in the US and EUR 20 bn in Eur o
shar e buy-backs. For cor por ates acr oss the spectr um, gener ally cr edit mar kets.4
speaking, it is a cheap insur ance policy against the r isk of sudden
death, should the economic r ecover y disappoint expectations.
5Fig. 8: Large amount of risk-adverse cash to be put at w ork in It is inter esting to note that the US HY mar ket has seen the shar e of
2021 (US Money Market Funds assets and Fed Funds rates) BB jumping fr om 48% to 55% of the total US HY outstanding, 7 as a
combination of fallen angels and new issuance. An additional
featur e of 2020 new issuance has been the r emar kable r ise in
secur ed debt in the HY space, mostly in this BB segment. 8 It is also a
smar t way to r otate por tfolios to sector s har dly affected by the
pandemic, wher e secur ed bonds ar e being issued. The outstanding
Per cent
USD Bn
pool of such a debt str uctur e is lar ge and liquid enough to attr act
investor s. We believe that this pr ovides an oppor tunity for
IG/cr ossover buyer s to impr ove car r y fr om low yielding IG bonds
while still maintaining some cr edit r isk pr otection that secur ed debt
offer s.
Fig. 10: The share of BB has jumped to 55% of US HY market
outstanding amid fallen angels and busy primary market
Sour ce: Macr obond, ICI, fr om January 1 st, 2017 to Decemeber 13th, 2020.
With less net issuance, r ising demand could compr ess cr edit spr eads
fur ther . The r oll-out of vaccines is changing the economic outlook,
Per cent
Per cent
but it is much too ear ly and uncer tain for policy suppor ts to be
r emoved. Left tail r isks ar e ther efor e diminishing notably.5 We
expect over all r isk appetite to be on aver age significantly higher
next year , which should tr anslate to a higher allocation to High
Yield amid better cyclical pr ospects. We noted that the pandemic
has led investor s to maintain high cash or ver y low r isk exposur e in
their por tfolio, which constitutes in our view an immense r eser voir
of r isk capacity for next year .
Fig. 9: US$18 tn of assets yielding negative in December 2020 ($
tn) Sour ce: Macr obond, ICE BAML indices, as of December 15th, 2020. US High
Yield Mar ket and sub rating components (H0A0, H0A1, H0A2, H0A3
USD tn r espectively all r atings, BB, B, CCC r ated companies)
Valuations: From Tight to … Tighter
The year -end r ally after the confir mation of the vaccine availability
and efficacy wer e confir med has been phenomenal. Cr edit spr eads
have compr essed almost back to Januar y levels. In yields ter ms, US
HY touched new histor ic lows, while Eur o and EM HY yields ar e little
distance away fr om 2018 lows. 9
Shor t ter m quantitative measur es (Z-scor e 6 months) ar e pointing to
spr eads enter ing expensive ter r itor y after the speed of the
compr ession in the last quar ter , but, in our view, longer ter m
hor izon pr ovides potential for fur ther compr ession of spr eads in
Sour ce: Bloomber g Barclays negative yielding outstanding, in USD, as of
2021.
December 13th, 2020.
In our view the sear ch for yield will be all the mor e impor tant, and When assessing the potential for each cr edit asset class to per for m
2021 is not a year to r emain uninvested. Par t of the r isk incr ease next year , total r etur ns pr ospects for IG ar e ver y closely linked to
yield dir ection, par ticular ly in the US. The massive new issuance in
will be thr ough cyclical asset classes like equities, but given cur r ent
2020 has acceler ated the incr ease in the aver age dur ation in US IG
elevated valuations, balancing this with a cr edit por tfolio makes
sense. With mor e than US$18 tn of fixed income assets tr ading at mar ket, to beyond 8 year s. 10 While all r ating categor ies have seen
negative yield, 6 the options ar e to go ver y long in dur ation or absor b an incr ease in dur ation, the BBB segment, now r epr esenting mor e
high cr edit r isk. Given the tight spr ead in IG, building income or than 50% of the US IG mar ket, saw its aver age dur ation lengthening
by mor e than half of a year over the past 12 months. 11
car r y str ategies will channel mor e liquidity in the High Yield
segment, in our view.
To enhance por tfolio yield, ther e ar e little options left but to go
“Credit spreads
ver y long in dur ation or to absor b higher cr edit r isk. Flows in 2020
ver y much favour ed aggr egate str ategies and IG cr edit due to have compressed
cyclical r isk aver sion. Given economic r ecover y on tr ack next year almost back to
and the tight spr ead in IG, building income or car r y str ategies will
likely channel mor e liquidity in the HY segment, in our view. January levels”
6 2019-12-13-3809The ar gument is less str iking in the Eur o mar ket, with the aver age Fig. 12: Emerging corporate spreads can offer value compared to
dur ation of the IG mar ket r ising by 0.3 year s only in 2020 up to 5.3 US spreads
year s. 12 In addition, the ECB Cor por ate Pur chase pr ogr amme is a
positive ar gument in favour of Eur o IG ver sus US IG. We would
expect the ECB to pur chase an aver age of EUR 6 to 7 bn of
cor por ate bonds monthly in 2021. 13 With net supply in EUR IG of
appr oximately EUR 160 bn in 2021, of which EUR 100 bn in non-
financials, ECB pur chases could r emove up to EUR 72-84 bn, leaving
ver y little non-financials supply to absor b by pr ivate investor s.14
Fig. 11: Further compression potential betw een HY and IG
spreads
Sour ce: Macr obond, ICE BAML indices, H0A0, C0A0, HEC0, ER00 as of
December 11th, 2020. Weekly data.
The emer ging mar ket (EM) pr emium has r emained elevated in 2020
despite the r ally since Mar ch 2020, and we believe is an oppor tunity
to impr ove entr y points into cr edit mar kets ver sus US or Eur o
domestic mar kets. Covid-19 was not an emer ging cr isis and did not
tr igger extr a exter nal financing issues. This allows emer ging
economies to r ecover at same or faster pace than developed
economies. The cur r ent pr emium in EM spr eads, IG as HY, has
fur ther compr ession potential in this context, and episodes such as
2010 or 2016/2017 demonstr ates the capacity of these cr edit
Sour ce: Macr obond, ICE BAML indices, H0A0, C0A0, HEC0, ER00 as of
mar kets to outper for m in global economic nor malisation phases with
December 11th, 2020. Weekly data.
no exter nal financing r isk. Relative to the US domestic mar ket, the
The case for HY spr ead compr ession is ver y much linked to technical spr ead per tur n of lever age is significantly higher for Emer ging
factor s mentioned above r egar ding supply/demand. A key cor por ate debt and pr ovides some mar gin r egar ding the point of
differ entiator in 2021, we believe, is the higher r isk toler ance in a entr y in tight valuations other wise. A weak USD r egime offer s a
multi asset cr edit por tfolio, which shifts the allocation for mor e complacent envir onment for such tr ades in our view.
car r y and less dur ation r isk. Given the tight spr eads in IG, a
Fig . 13: Emerg ing Corporate credit premium not fairly priced yet
potential r isk-adjusted r etur n option goes thr ough incr easing the HY
(Spread per turn of leverage, bps/X)
weighting and seeks to captur e the step-up in yield with lower
inter est r ates dur ation.
Investor s may have legitimate questions about entr y points at A 28
39
cur r ent valuations. We think, however , that fur ther compr ession is
US
possible, especially in r elative value acr oss cr edit quality. The
BBB
BBB 30 EM
r ecent r ally has seen US HY per for mance outpacing US IG, but when 54
consider ing the r atio of HY to IG, it still r eflects levels seen in times
of tension such as 2015 and we believe the compr ession tr ade has 58
BBB
BB
fur ther to go. The fir st months of 2021 may look like the r ecover y 93
seen in 2016, when the compr ession lasted sever al months in a
falling yield envir onment. A similar obser vation is easily made on BBBB 70
132
the Eur o HY/IG mar ket but with additional motivation to shift
allocation to higher yielding assets: 45% of the Eur o IG is yielding
below zer o at mid-December 2020! 15 Sour ce: Bank of Amer ica EM Corporate Credit Chartbook, as at end of
November 2020.
The last few months’ r ally in cr edit mar kets benefited bonds mor e
than lever aged loans. The pr obable pr efer ence for liquidity put
bonds on the fir st r isk-taking wagon, with mor e convexity and catch-
“We think further up potential. With close to 70%16 of the HY mar ket tr ading at call
compression is pr ice or above, the sear ch for yield of next year may consider the
possible, especially lever aged loans mar ket as an attr active car r y oppor tunity.
in relative value
across credit
quality”
7With a discount mar gin of close to 5% for US lever aged loans, 4.6%
for Eur opean Loans, combined with a pull-to-par of potentially 2%
to 3% for the US mar ket and 1.5% for Eur o mar ket 17 , the r etur n
per spective in a car r y envir onment for 2021 looks meaningfully
“We believe
mor e attr active than other segments of the High Yield mar kets. In technical factors
our view two technical factor s would str engthen the valuation will support credit
ar gument. In both the USD and Eur o mar ket, CLO pr inting is
expected to acceler ate in 2021, after some slowing down in 2020. 18 markets”
Retail investor s in the US have deser ted the asset class for a couple
of year s, but we believe these flows could r etur n in 2021 given the
level of car r y.
Figs. 14 and 15: Yield per Corporate credit and Treasuries sub- Conclusion
segments
6 6
5.17
The vaccines deployment acted as a “r eset button” for cr edit
5 4.46 5 mar kets, which can build a mor e stable per spective in the medium
3.96 ter m. We ar e cognizant that some hur dles still exist in the shor t-
4 4 ter m that will r equir e a car eful investment appr oach to navigate
Yield to Wor st
r emaining volatility over the next couple of quar ter s. We believe,
3 3 however , that technical factor s will suppor t cr edit mar kets, and
1.98
will lead to fur ther compr ession of cr edit spr eads in the fir st half of
2 1.53 2
2021. In an envir onment wher e levels of yields have fallen back to
ver y low levels in a for midable post-pandemic r ally, we view the
0.78 absolute need for yield as the most power ful engine for channelling
1 1
r isk-adver se money of 2020 into high yielding assets. We need to
0.12
walk in with eyes wide open when it comes to valuations, but we
0 0 can be confident on fur ther meaningful compr ession of spr eads,
0 2,000 4,000 6,000 8,000 10,000 12,000 14,000 16,000 18,000
befor e it becomes incr easingly uncomfor table not to see
Mar ket value USD
inter r uption of such a tr end.
US Loans US High Yield EM $ Corp
US Non- Financials IG US Financials IG Tbonds 7-15y
Sour ce: Cr edit Suisse Leveraged Loans Index USD, Western European
Lever aged Loans Index non-USD denominated, ICE BAML indices, H0A0, HEC0,
EMNF, CF0X, CF00, EN00, EF00, G402, G102, EG14, EG11, as of December
15th, 2020.
5 5
3.88
4 4
2.86 3
3 3
Yield to Wor st
2 2
1 0.21 1
-0.09 -0.67 -0.64
0 0
-1 -1
0 2,000 4,000 6,000
Mar ket value EUR
Euro Loans Euro High Yield
EM Corp (Eur Hdged) Euro Non-Financials IG
Euro Financials IG Euro Government AAA 7-10y
Euro Government AAA 1-3y
Sour ce: Cr edit Suisse Leveraged Loans Index USD, Western European
Lever aged Loans Index non-USD denominated, ICE BAML indices, H0A0, HEC0,
EMNF, CF0X, CF00, EN00, EF00, G402, G102, EG14, EG11, as of December
15th, 2020.
8 2020-12-16-54541 IMF Fiscal Monitor , October 2020. 2FOMC Member s pr ojections on Fed Fund r ates, December 16th, 2020, Eur opean Centr al Banks Pr esident Lagar de pr ess confer ence and ECB for ecasts as of December 10th, 2020. 3December ECB Staff economic pr ojections r eleased on December 10th, 2020. 4Goldman Sachs, 2021 Global Cr edit Outlook: “Same dir ection, differ ent magnitude” as of November 18th, 2020 5 Left-tail r isks on a nor mally distr ibuted cur ve 6Bloomber g Bar clays Negative Yielding Outstanding Index as of December 11th, 2020. 7ICE BAML Indices, H0A0, H0A1 for BB between December 31st, 2019 and December 14th, 2020. 8 HY Yield Cr edit Char tbook, BofA, as of December 2nd, 2020. 9 ICE Bofa, US High Yield Index H0A0, HEC0 Eur o High Yield Constr ained index, EMHY Emer ging Mar kets Liquid Cor por ate Plus Index. 10ICE BofA C0A0 US cor por ate Index, ICE BofA C0A4 US BBB Cor por ate Index. 11ICE BofA C0A0 US cor por ate Index, ICE BofA C0A4 US BBB Cor por ate Index. 12ICE BAML Indices, Eur o IG mar ket ER00 index, as of December 14th, 2020. 13JPMor gan Eur opean Cr edit Outlook & Str ategy 2021: A Life less Extr aor dinar y, as of November 17th, 2020. 14 JPMor gan 2021 Eur o cr edit outlook. 15 HY Yield Cr edit Char tbook, BofA, as of December 2nd, 2020. 16 BofA High Yield Cr edit Char tbook as of December 2nd, 2020. 17Cr edit Suisse Lever age Loans Index USD, as of December 11th, 2020. 18 Cr edit Suisse Cr edit str ategy Daily (November r ecap) December 4th, 2020. 9 2020-12-16-5454
Impor tant Infor mation
Muzinich & Co. r efer enced her ein is defined as Muzinich & Co., Inc. and its affiliates. This document has been pr oduced for i nfor mation
pur poses only and as such the views contained her ein ar e not to be taken as investment advice. Opinions ar e as of date of pub lication and
ar e subject to change without r efer ence or notification to you. Past r esults do not guar antee futur e per for mance. The value of
investments and the income fr om them may fall as well as r ise and is not guar anteed and investor s may not get back the full amount
invested. Rates of exchange may cause the value of investments to r ise or fall. This document and the views and opinions expr essed
should not be constr ued as an offer to buy or sell or invitation to engage in any investment activity; they ar e for infor mati on pur poses
only. Opinions and statements of financial mar ket tr ends that ar e based on mar ket conditions constitute our judgement as at t he date of
this document. They ar e consider ed to be accur ate at the time of wr iting, but no war r anty of accur acy is given and no liabili ty in r espect
of any er r or or omission is accepted. Cer tain infor mation contained in this document constitutes for war d -looking statements; due to
var ious r isks and uncer tainties, actual events may differ mater ially fr om those r eflected or contemplated in such for war d -looking
statements. Nothing contained in this document may be r elied upon as a guar antee, pr omise, assur ance or a r epr esentation as t o the
futur e. All infor mation contained her ein is believed to be accur ate as of the date(s) indicated, is not complete, and is subj ect to change
at any time. Cer tain infor mation contained her ein is based on data obtained fr om thir d par ties and, although believed to be r eliable, has
not been independently ver ified by anyone at or affiliated with Muzinich and Co., its accur acy or completeness cannot be guar anteed.
Risk management includes an effor t to monitor and manage r isk but does not imply low or no r isk. Emer ging Mar kets may be mor e r isky
than mor e developed mar kets for a var iety of r easons, including but not limited to, incr eased political, social and economic instability;
heightened pr icing volatility and r educed mar ket liquidity. In Eur ope, this mater ial is issued by Muzinich & Co. Limited., which is
author ised and r egulated by the Financial Conduct Author ity. Register ed in England and Wales No. 3852444. Register ed addr ess: 8
Hanover Str eet, London W1S 1YQ. Muzinich & Co. Limited. is a subsidiar y of Muzinich & Co., Inc. Muzinich & Co., Inc. is a r egister ed
investment adviser with the Secur ities and Exchange Commission. Muzinich & Co., Inc.’s being a r egister ed investment adviser with the
Secur ities Exchange Commission (SEC) in no way shall imply a cer tain level of skill or tr aining or any author ization or appr oval by the SEC.
Index Descriptions
You cannot invest dir ectly in an index, which also does not take into account tr ading commissions or costs. The volatility of indices may
be mater ially differ ent fr om the volatility per for mance of an account or fund.
Bloomber g Bar clays Global Aggr egate Negative Yielding Debt Index - The Bloomber g Bar clays Global Aggr egate Negative Yielding Deb t
Index measur es the per for mance of appr oximately 2500 secur ities which cur r ently car r y negative yields. The index is unhedged and
cur r ently has an estimated mar ket value of 11 tr illion dollar s in USD.
H0A0 -The ICE BofA ML US High Yield Index tr acks the per for mance of US dollar denominated below investment gr ade cor por ate debt
publicly issued in the US domestic mar ket. Qualifying secur ities must have a below investment gr ade r ating (based on an aver a ge of
Moody’s, S&P and Fitch), at least 18 months to final matur ity at the time of issuance, at least one year r emaining ter m to fi nal matur ity
as of the r ebalancing date, a fixed coupon schedule and a minimum amount outstanding of $250 million.
H0A1 - The ICE BofA ML BB US High Yield Index is a subset of the ICE BofA ML US High Yield Index (H0A0) including all secur ities r ated BB1
thr ough BB3, inclusive.
H0A2 - The ICE BofA ML single-B US High Yield Index is a subset of the ICE BofA ML US High Yield Index (H0A0) including all secur ities r ated
B1 thr ough B3, inclusive.
H0A3 - The ICE BofA ML CCC & Lower US High Yield Index is a subset of the ICE BofA ML US High Yield Index (H0A0) including all s ecur ities
r ated CCC1 or lower .
C0A0 - The ICE BofA ML US Cor por ate Index tr acks the per for mance of US dollar denominated investment gr ade cor por ate debt public ly
issued in the US domestic mar ket. Qualifying secur ities must have an investment gr ade r ating (based on an aver age of Moody’s, S&P and
Fitch), at least 18 months to final matur ity at the time of issuance, at least one year r emaining ter m to final matur ity as of the
r ebalancing date, a fixed coupon schedule and a minimum amount outstanding of $250 million.
C0A4 - The ICE BofA ML BBB US Cor por ate Index is a subset of the ICE BofA ML US Cor por ate Index (C0A0) including all secur ities r ated
BBB1 thr ough BBB3, inclusive.
CSELLI - CS Lever aged Loan Index – The CS Lever aged Loan Index is designed to mir r or the investable univer se of US dollar denominated
lever aged loan mar ket. The index is r ebalanced monthly on the last business day of the month instead of daily. Qualifying loans must
have a minimum outstanding balance of $100 million for all facilities except TL A facilities (TL A facilities need a minimum outstanding
balance of $1 billion), issuer s domiciled in developed countr ies, at least one-year long tenor , be r ated “5B” or lower , fully funded and
pr iced by a thir d par ty vendor at month-end.
ER00 – The ICE BofA ML Eur o Cor por ate Index tr acks the per for mance of EUR denominated investment gr ade cor por ate debt publicly i ssued
in the eur obond or Eur o member domestic mar kets. Qualifying secur ities must have an investment gr ade r ating (based on an aver age of
Moody’s, S&P and Fitch), at least 18 months to final matur ity at the time of issuance, at least one year r emaining ter m to fi nal matur ity,
a fixed coupon schedule and a minimum amount outstanding of EUR 250 million.
HEC0 - The ICE BofA ML Eur o High Yield Constr ained Index contains all secur ities in the ICE BofA ML Eur o High Yield Index (HE00) but caps
issuance exposur e at 3%.
EM2R – The ICE BofA ML BBB US Emer ging Mar kets Liquid Cor por ate Plus Index is a subset of the ICE BofA ML US Emer ging Mar kets Li quid
Cor por ate Plus Index (EMCL) including all secur ities r ated BBB1 thr ough BBB3, inclusive.
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www.muzinich.com www.muzinichprivatedebt.com info@muzinich.com
New Yor k London Dublin Fr ankfur t Geneva Hong Kong Madr id Manchester Milan Palm Beach Par is Singapor e Sydney Zur ich
New Yor k London Dublin Flor ida Fr ankfur t Geneva Hong Kong Madr id Manchester Milan Par is Singapor e Sydney Zur ichEMNF – ICE BofA Non-Financial us Emer ging Mar kets Liquid Cor por ate Plus Index is a subset of The ICE BofA US Emer ging Mar kets Li quid
Cor por ate Plus Index excluding all Financial secur ities as well as debt of cor por ate issuer s designated as gover nment owned or contr olled
by ICE BofA emer ging mar kets cr edit r esear ch.
CF0X – ICE BofA US Non-Financial Index tr acks the per for mance of non-financial US dollar denominated investment gr ade cor por ate debt
publicly issued in the US domestic mar ket.
CF00 – ICE BofA US Financial Index is a subset of ICE BofA US Cor por ate Index including all secur ities of Financial issuer s.
EN00 – The ICE BofA ML Eur o Non-Financial Index tr acks the per for mance of non-financial EUR denominated investment gr ade cor por ate
debt publicly issued in the Eur obond or Eur o member domestic mar kets. Qualifying secur ities must have an investment gr ade r at ing (based
on an aver age of Moody’s, S&P and Fitch), at least 18 months to final matur ity at the time of issuance, at least one year r emaining ter m
to final matur ity as of the r ebalancing date, a fixed coupon schedule and a minimum amount outstanding of EUR 250 million
EF00 – ICE BofA Eur o Financial Cor por ate & Pfandbr ief Index tr acks the per for mance of EUR denominated investment gr ade pfandbr ief and
non-pfandbr ief financial cor por ate debt publicly issued in the Eur obond or Eur o member domestic mar kets.
G402 – The ICE BofA ML 7-10 Year US Tr easur y Index is a subset of the ICE BofA ML US Tr easur y Index (G0Q0) including all secur ities wit h a
r emaining ter m to final matur ity gr eater than or equal to 7 year s and less than 10 year s.
G102 – ICE BofA 1-3 Year US Tr easur y Index is a subset of ICE BofA US Tr easur y Index including all secur ities with a r emaining t er m to final
matur ity less than 3 year s.
EG14 - ICE BofA 7-10 Year AAA Eur o Gover nment Index is a subset of ICE BofA Eur o Gover nment Index including all secur ities with a
r emaining ter m to final matur ity gr eater than or equal to 7 year s and less than 10 year s and r ated AAA.
EG11 - ICE BofA 1-3 Year AAA Eur o Gover nment Index is a subset of ICE BofA Eur o Gover nment Index including all secur ities with a
r emaining ter m to final matur ity less than 3 year s and r ated AAA.
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www.muzinich.com www.muzinichprivatedebt.com info@muzinich.com
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