December 24, 2024 • 47 mins
A sustained period of elevated interest rates has the potential to cause pain in the fastest-growing part of corporate debt, according to RBC Global Asset Management. “We are concerned about how the direct lending private credit space would deal with a higher-for-longer world,” said Andrzej Skiba, the firm’s head of US fixed income. “You’re much better off in public markets because the leverage profile, the interest coverage ratios are just so much better,” he tells Bloomberg News’ James Crombie and Bloomberg Intelligence senior credit analyst Mike Holland, in the latest Credit Edge podcast. Holland and Skiba also discuss value in financial-sector debt, technology and media bond opportunities, coercive liability management exercises and 2025 bond market returns.
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Episode Transcript
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Speaker 1 (00:18):
Hello, and welcome to The Credit Edge, a weekly markets podcast.
My name is James Crombie. I'm a senior editor at Bloomberg.
This week, we're very pleased to welcome Andre Skiba, head
of US fixed Income for RBC Global Asset Management. How
are you, Andre, Very well, pleasure to be with you.
Thank you so much for joining us. Stay very excited
to have you on the show. Also delighted to have
back as our co host Mike Holland with Bloomberg Intelligence.
Speaker 2 (00:40):
Hello, Mike, Hey, James, Hey Andre, Great to be here.
Speaker 1 (00:43):
Great. So, just before we start talking, I just wanted
to say a few words about where we are now.
US markets are rallying as rates come down, the economy
keeps chugging along, and investors look forward to a new
US administration, which the bulls think will be very pro
grow and pro markets credit markets, and meanwhile on fire,
there's a ton of demand for yield. No one seems
(01:05):
to mind that bond spreads are the titus in twenty years,
but that doesn't mean there's no risk. The Fed is
cutting rates, but they are going much slower than most
people have been expecting, and treasury yields are stuck above
four percent, while the stated aims of the next government
all look very inflationary, signaling a period of higher for
longer interest rates, and that means elevated debt costs, which
(01:25):
will put borrowers in the weaker part of the market
in a difficult spot for next year. We've already seen
a ton of defaults and bankruptcies in private markets. There's
more mending and extending of bonds and loans, while some
lenders are having to get repaid with more debt, and
there's more of this so called payin kind activity, which
(01:47):
isn't always good news. And in the background, we have
a huge amount of geopolitical risk which will be amplified
by the Trump trade wars. Maybe that just makes US
assets even more compelling on a relative basis, but there's
seal potential for a lot more voldaceity across all credit markets.
So Andre, what does that mean for twenty twenty five?
Are you bullished for next year?
Speaker 3 (02:06):
Well, we expect a lot of volatility, So we bullish
on volatility coming and hitting us soon as the market
grapples with the new administration and the new policy mix.
But we do believe that eventually, once the dust settles
and investors understand what this administration is trying to achieve
(02:27):
and what is the response of the Federal Reserve and
FOMC to this new policy mix. Once the dust settles,
we do think people will re engage with fixed income
and will like historically attractive yields.
Speaker 1 (02:40):
But so, how does it take the dust settle? It
looks like there's a lot of dust coming. Is it
going to be years before we know what's going on?
Speaker 4 (02:47):
Oh, God forbid.
Speaker 3 (02:48):
We're hoping to have more clarity over the first few
months of the year, And to us, like the biggest
question is really to do with stands towards trade. During
the campaign, we've heard again and again the willingness to
consider ten percent tariffs on most trade partners and most
(03:09):
goods on top of tariffs regarding China, and if that
were to happen, it would have very negative implications both
in terms of inflation and fixed income in our opinion, If, however,
we get a more benign trade rhetoric playing through where
(03:31):
it's used as a transactional tool, for example, in the
context of questions about immigration, but there is no broader
escalation that has more of a global nature in that
world inflation is less likely to spike, and we do believe,
based on other conversations with people on the hill, people
(03:52):
in the incoming administration, that investors should have clarity which
of those two options incoming team chooses in the first
two three months of the year.
Speaker 2 (04:05):
Hey, Andre, it's my colin here. Looking across your funds managed,
seems like you had a really strong year, right, you know,
you look at investment great returns around six percent, some
high yield and loan funds up nine, you know, approaching
ten percent. If as you think about you know, you
mentioned volatility and being long, you know, maybe being long
vol Is there a way that you execute that view
(04:27):
in your funds? I mean, are you able to cross funds,
you know, express views, maybe through index options or other
ways to capitalize on that volatility expectation?
Speaker 3 (04:38):
Well from for most of the strategies that we manage
that benchmarked type strategies, the way to position for incoming
volatility is very simple. Reduce risk and rather than hedging
and wedging your portfolios adding layers of derivative protection, that
(05:01):
is a strategy that works for a short period of time.
But history shows again and again that if you want
to do risk, you need to sell bonds. If you
want to do risk, you need to reduce your exposure
to longer duration assets, and that is the best way
to weather any storms or pick up in volatility. So yes,
(05:21):
absolutely we see a role for the derivative solutions within
our strategies to address the spike in volatility, but it
can't be the main way to address that vole. The
main one is reduce risk, cut risk.
Speaker 1 (05:40):
What does the return of volatility mean for spreads under
in a You know, we're hearing some very aggressive calls
for spreads to keep going tighter because there's not enough
supply and more demand, and you know, people really don't
care that much about spres. They care more about yield.
So one of our guests suggested that the ig US
could go to fifty five basis points, which is the
since nineteen ninety seven, and then we are someone on
(06:02):
the high ould side. They said that, well, that would
mean that junk we'll go to two twenty five, which
has never been seen.
Speaker 3 (06:07):
It really depends on the environment we're going to have
ahead of us. If the more benign version of the
Trump administration happens and inflation does not see appward pressure,
which allows for the FED to cut rates. We do
believe there's an absolute ton of money that wants to
(06:27):
be put to work in further out the curve in
fixed income. Like we look at money market balances the
close to historical highs, So even if a fraction of
that goes into fixed income, it could have meaningful implications
for spreads. The same goes for foreign investors. We're hearing
again and again about the attractive level of yields in
(06:51):
US fixed income from our foreign clients. And even though
in some jurisdictions the hedging costs are a major issue,
there's still a ton of money to you put to work.
So yes, there is a possibility where in a very
benign trade scenario, in a world where, for example, the
new administration is successful in reducing deficit through all the
(07:15):
cost cutting measures that have been announced in that world,
spreads go aggressively tighter and a credit spread becomes just
a number. It just becomes a derivative of the heaviness
of flows coming into the asset class. But that is
clearly not our base case scenario. In our view, you
are much more likely to have a bit of a
(07:37):
wake up call for investors realizing that spreads don't just
go tighter ad infinitum, but actually there is such thing
as volatility. There is such thing as risk transfers that
push spreads wider as investors recognize a shift in the
policy mix and federal reserves posture towards the market. So
(07:59):
from our perspective, widening up spreads in the beginning of
the year, possibly even approaching one hundred basis points in
investment grade and definitely crossing three hundred basis points in
high yield is very much possible. So that that is
the scenario we're really positioning ourselves.
Speaker 2 (08:15):
Full that would be against the view that we had
at our big credit conference a couple of weeks ago,
when Matt Brill from Invesco was pointing out that fifty
five basis point target. You know, it did seem this
seems to be a lot of bullishness, and I tend to,
as a credit analyst by trade, be a little more
negative and concerns. So I share your views on that. Andre,
I would like to kind of move aside and ask
(08:37):
you a little bit about market technicals. And you know,
I grew up in Loanland as a credit analyst, and
then I moved on to bonds. I've covered, you know,
all sorts of different asset classes on the credit side,
and I wonder, you know, looking at the market today,
we've got something like twelve or thirteen billion of new
high field issuance in healthcare high old bonds, you know,
(08:57):
maybe eighteen billion or so of private credit Bloomberg's tract
of healthcare related issues, and then one hundred and twenty
one hundred and fifty depending on how you cut it,
of a billion of loans. So the high old bond
market structurally, it seems like it's getting smaller, right, And
some of the riskier deals, the sponsor back deals, are
going to private credit. And I wonder if you see
(09:19):
that as supportive to the market, despite the risks that
are rising every day, it seems do you see that
as supportive to the market, you know, in twenty twenty five,
maybe on high yield.
Speaker 4 (09:30):
It's definitely a possibility.
Speaker 3 (09:32):
Like when we speak to investors across the US, everyone
hates high yield. Everyone moans about the fact that spreads
are very tight by historical standards, and that is almost
the mantra that we're here again and again. Well in
a way that creates a positive technical because you have
no hot money coming into high yield at this time.
(09:55):
It also helps that flows have stabilized in the highl
while you still have money coming into private credit space.
So it has been absolutely helpful to have capital flowing,
whether into private credit or into leverage loan market to
help address idiosyncratic issues that could be plaguing our sectors.
(10:20):
So issuers find refinancing solutions in markets other than where
they started in. So you might have had a bond
that you need to address and instead of refinancing that
in the bond market, you could have opportunities, be it
in leverage loan or in a private credit space, and
that's definitely something that reduces the likelihood of a spike
(10:44):
in defaults across the entire leverage finance stack. And while
the technicals are quite favorable with issuance not being too
heavy most of the activity being to do with refinancing
rather than new that funded acquisitions for example, all that
(11:05):
creates a relatively positive backdrop for high yield. Having said that,
let's not fool ourselves, there will be pockets of the
market where the where investors will punish too much leverage
no cash flow in a higher for longer world, or
very aggressive structures that are struggling in an economy that
(11:30):
might be slowing down a bit.
Speaker 4 (11:32):
So I'm not.
Speaker 3 (11:33):
Saying that across the entire stack of high yield it
will be a party. Across twenty twenty five. There will
be pockets that will feel pretty ugly. But from our perspective,
the fact that companies have multiple avenues to address the issues,
in multiple markets to go to to address these issues,
while at the same time there's not like a wave
(11:54):
of hot money that has hit high yield that might
reconsider its decision, creates a relatively positive backdrop. It doesn't
mean that spreads can't go wider. It just means that
it's very difficult to imagine very ugly price action in
high yield over the coming quarters.
Speaker 1 (12:13):
You say, everyone hites high yeld, but that's done so
well in multiple seeds at fifteen percent this year, so
that must be attracting some of this kind of money.
Speaker 3 (12:21):
Now, well, that's the irony of the situation that the
market that has done the best out of the public
market was the one that throughout the entire year everyone
was moaning about spreads being at unattractive levels and only
yields looking relatively attractive by historical standards. We're not seeing
(12:41):
an avalanche of money coming in. We have noticed that
a fair amount of investments in high yielding assets have
gone into private credit space, and that has been the
main beneficiary over the recent years of flows, with high
yield kind of being a far distant second or third
(13:04):
beneficiary in that respect. So we're not really seeing that
dynamic change.
Speaker 1 (13:09):
And do you expect triple c is to continue to
perform at this level to make more double digit returns
next year?
Speaker 3 (13:16):
It's difficult to envisage that you're going to have such
strong performance as you had this year. And part of
the strong performance in twenty twenty four was to do
with investors' positioning for more economic weakness and more vulnerability,
whereas US has again shown to be so resilient and
that has primarily benefited triple C issuers. But it's fair,
(13:41):
it's fair to admit that even though there are a
lot of Triple C credits that are getting to valuations
where it's difficult to be excited and it's pretty much
of a glass half full version of events that is
priced in rather than the more conservative scenario. You also
have quite a lot of situations, especially those in vault
battles between bondholders and companies or bondholders and other debt holders,
(14:06):
where you have quite binary outcomes and many of those
triples rate that issuers could see meaningful either price appreciations
of the clients depending on how those battles play out.
So that is one corner of the market, the big
kind of co op structures and you know creditor and
on creditor violence and issue on creditor violence where binary
(14:30):
outcomes are still possible in twenty twenty five, that could
significant impact returns in triple C stack.
Speaker 2 (14:38):
Yeah, I mean if you look at Bouche Health, right,
we been talking about Bouche Health for a long time,
but you know, four years ago they talked about spinning
out Bauscham Home and really benefiting the equity holders of
that company to the detriment of bondholders. And it's been
a long road and they're still working on you know,
progress there, but it's been one of these the the
(15:00):
biggest contributors to you know, positive returns in the high
yield space, at least in high old healthcare. You know,
the bonds are up twenty thirty points the longer data
on securitage. The term loan is up something like eighteen
points this year. And I've had a lot of questions
from clients saying, you know, why does the co op
agreement drive a technical You know, there wasn't a ton
(15:21):
of fundamental change with BA or Bouschelt this year, right,
and if the bonds went.
Speaker 4 (15:25):
Up like that.
Speaker 2 (15:25):
A lot of folks are pointing to the co op
agreements saying, you know, if you're not trading and there's
folks picking off bonds on the side, you know, that's
just driving a positive technical And what does that look
like going forward? Is that something that co op agreements
is there's just the positive outcome of owning a bond
and going into an agreement like that. Is that something
that you've talked about with your investment committees or some
of your clients.
Speaker 3 (15:47):
Well, we see two sides of this coin. On one side,
it's not just a question about co ops. It's also
a question whether you investeering commits you have a COP
because you might end up having different a mix compared
to the rest of the group. So that brings about
question about size and how large exposure would you like
(16:08):
to have to a particular issuer, which also comes with
its downside. So that's first aspect to highlight often differing economics.
The other one is a lot depends on what is
the starting position that investors had in a particular issuer.
If you have a name that was quite unloved, where
(16:30):
investors were frustrated with management, financial policy and the outcome
for the credit, and you have a co op forming,
that can lead to a positive price action because the
likelihood of negotiating better outcomes increases. Having said that, we
have plenty of examples of co ops that happened in
(16:51):
situations where you had an issuer that was a consensual
long for the market, and instead of boosting the valuations
further when a co op formed, the effect was the opposite,
where the marginal bias of those securities have essentially evaporated
(17:12):
because everyone was already pregnant.
Speaker 4 (17:15):
With that risk.
Speaker 3 (17:16):
And and that meant that on the follow through from
the co op forming, you had weaker trading of the
security in the weeks that followed. So initial positioning in
the name actually drives quite a lot of that response
to co opforming.
Speaker 2 (17:36):
That makes a lot of sense. I wonder too, though
you know you've been doing this a while, when you
see a co op agreement or the rise and co
op agreements like we've seen in the last several years,
do you think that's indicative of sort of a trend
toward away from syndicated bonds. If you have to negotiate
(17:57):
with a bunch of you know, bond holders that previous
we could pit against each other, and now they're operating
as one unit more or less, why not just go
to the private debt market going forward?
Speaker 3 (18:08):
I can see the attraction of that, and I agree
that having group of debtholders at sometimes diverging interest because,
for example, some of the holders could be in secured
part of the capital structure, some could be in the
unsecured part of the capital structure, and the objectives could
be different, and sometimes it's the same institution that has
(18:30):
holdings in both. That makes for a more complicated setup,
whereas reverting to a private market solution could be neater
for issuers going forward. And indeed, we actually have seen
examples of idiosyncratic stories where issuers facing pretty tricky circumstances
(18:54):
or a story that is not the easiest for the
market to absorb when down the route of private credit
rather than staying in the public markets to address the need,
so that trend can easily continue.
Speaker 4 (19:05):
And also it's.
Speaker 3 (19:07):
Fair to admit that for as long as money keeps
flowing into the private credit space, into the direct lending
private credit space, that market will have an incentive to
absorb some of those situations from public space, as all
this money is competing for opportunities to be invested into.
Speaker 1 (19:25):
On the private side. Andre we're talking about a twenty
trillion dollar market now that doubles in size over the
next five years potentially, according to one of our guests,
does that mean a great opportunity for you? I mean,
in terms of the investor proposition, what we're being told
is that it's much more return and much less risk.
Speaker 3 (19:44):
Well to us, it really depends on which corner of
the private credit space you're looking at, because you know,
when we're looking at that universe and you consider asset
classes like infrastructure, distressed investing, special situations, all those are
perfectly legitimate, very interesting areas that can easily grow and flourish.
(20:06):
Where we had concern over the recent years is in
the direct lending private credit space. Because to us, especially
when looking at an environment where higher for longer could
very much be the mantra for central bank in the
US that has meaningful negative implications for that asset class
(20:29):
when you think about this excluding ad backs, because that
is something that is very prevalent within the space. But
if you exclude ad backs and look at pure kind
of cash profitability, mid market leverage is running at six
and a half seven times, and when you're paying at
current level of rates, kind of double digit cost of funding,
(20:54):
you can straight away make a calculation that three quarters
of your EBITDA goals just to service your interest costs
before you spend any money on capex, on working capital,
on whether you have any tax obligations. So we see
a situation where structurally you have a space with very
little if any cash flow being generated, and that is
(21:17):
something that can last for a little while, but it's
not something that can be last for a multi year period.
And if indeed we staying a higher for longer in
the US because inflation remains sticky, we do see worries
about that space having very little financial flexibility, where most
(21:40):
of the issuers suffer the same problems of dealing with
double digit cost of funding with little cash flow to
show for, and you know, then you start thinking from
the perspective of privatecor responses in specific situations. Yes, you
can write a check and help to bail out a
(22:00):
particular issue or kick the can down the road. However,
if you're seeing that dynamic across your entire portfolio, then
you're going to be asking yourself twice, Okay, what kind
of an echo check did I write in the first place?
Have I already taken distributions from this investment? And if
the answer is yes, then why should I deal with
(22:20):
that problem that holders might have to deal with the
fallout from such circumstances. So we are concerned about how
direct lending private credit space would deal with a higher
for longer world where US economy is slowing down at
(22:40):
the same time, and absolutely there could be growth in
the future, but in the very near term that particularly
corner of the private credit space, we have a lot
of concern about.
Speaker 1 (22:52):
Do you think there'll be a lot more defaults there?
Speaker 4 (22:55):
Well, we're already seeing.
Speaker 3 (22:58):
Action to help address challenges that are happening at the
stage with the rise of the payment in kind usage
within the space, but it's not a permanent solution, so
that's more symptomatic of the problems that are happening there.
(23:18):
And yes, if we live in this higher for longer
world where instead of cutting rates, FED might have to
even consider potentially hiking rates, which is not our base
case scenario, but it's not outside of the realm of possibility,
especially if that aggressive trade war were to happen in
that world. Yes, there's definitely going to be more pain
(23:39):
across the direct lending private credit as a class, and
we absolutely believe that you're much better off in public
markets because the leverage profile, the interest cover ratios are
just so much better and a lot of those pressures
are far less acute.
Speaker 1 (23:58):
So across the board in private market, is you think
that there's there's more value in public even in the
sort of non distressed side of it, Well.
Speaker 3 (24:07):
We were generally observed that when you're looking at returns,
we're not calling for a dramatic wave of the faults
within the asset class, but when you consider relatively high
fees within those products, net of fees and net of
some selective restructurings that have to happen, we think, you know,
(24:28):
it's quite easy to make numbers work for a public
alternative with much more liquidity and much more ability to
reposition if you want to.
Speaker 4 (24:36):
So why take the risk?
Speaker 2 (24:38):
That's a good question. I wonder. You know, there's been
a lot of commentary about some of these private lenders
moving up the rating spectrum and participating in investment grade
financing is oftentimes their project finance. But what's your view
on that? I mean, I've been covering high yield for
a very long time, and I've been covering a lot
of the companies that were sponsored by you know, some
(24:59):
of these private equity now private debt shops that now
are looking into investment grade. I wonder what's your take
on that.
Speaker 3 (25:07):
Well, to us, it's really a function of how much
money has been invested in that space and that money
needs to be put to some use. And at the
same time, when you have very aggressive issuance in investment grade,
where some market observers are even estimating close to two
trillion that could be issued in twenty twenty five, that
(25:30):
would be on the higher end of the market expectations,
but that would be a huge increase compared to where
we were a few years ago. That creates opportunities for
some of money from other market segments to be put
to work, especially in slightly more complex moesoteric structures where
(25:51):
traditional investment grade investors are not as keen to a
jump on that bandwagon so much supply. Absolutely, it's opportunities
for money coming from various pockets to be put to work.
Speaker 4 (26:05):
Yeah, it strikes me.
Speaker 2 (26:06):
As a novel play where but like you said, if
you've raised enough money, you got to put it to work.
You're just going to expect lower returns over time. I
guess stepping back a little bit, you know, that's an
opportunity I guess for those those shops that are doing that.
But you know, in your shop and when you're talking
with investment committees, going from opportunities to risks, back to risks,
(26:28):
what are the two or three you know? I mean,
we have a lot of geopolitical risks, We have issues
across the board. What are the two or three that
are top of mind for you guys right now with
your investors, with your investment committees.
Speaker 3 (26:42):
Well, I think the number one question that we're being
asked by our clients and prospect is what kind of
a rate cycle will we have in twenty twenty five?
Because that, depending on your risk appetite, will drive total
return outloads across fixed income.
Speaker 4 (27:02):
If you're looking.
Speaker 3 (27:03):
At high yield assets, then you're less reliant on what's
happening in the rate world. You know, your double B
assets are definitely more sensitive to that, but across how
other parts of the rating stack you are less vulnerable.
And you know that's one of the reasons why here
to date HYLD has done better than high grade in
(27:24):
this respect, but particularly for investment grade investors, when you're
looking at projections of total returns, actually it's far less
your decision about where spreads will be over the course
of the twenty twenty five but more what level of
tenure treasuries will we have that will drive your total
(27:45):
return expectations. So that's clearly number one question that we get,
and in that context, to us, this question is absolutely
intertwined with a discussion about the new Trump administration policy mix,
especially when it comes to trade and how that's going
to play out in early months of next year. So
that's that's first order of business, and the other one
(28:10):
that we're also hearing quite a lot from investors is
questions about US exceptionalism.
Speaker 4 (28:17):
Is question whether given.
Speaker 3 (28:21):
Broad malaise in so many other parts of the world
where enthusiasm about any growth recovery is diminishing fast. Even
in China, where we had this burst of optimism a
few weeks back, quite a bit of that is already fading.
Can US maintain an edge over other parts of the world,
(28:44):
and does that also mean that valuations of US assets
will be will remain at the premium compared to some
of the offshore alternatives, so that that whole idea of
US exceptionalism and continue in that story. Can continuing in
twenty twenty five is very much on top of investors' minds.
Speaker 1 (29:04):
When you look at issuance. Andrea Youman mentioned this two
trillion dollar investment grade number. You know, we're hearing more
like I know one point six. But still even if
it if it is a high gross, the net still
seems to be quite low. I mean, there's so much
refinancing going on, there's maturities and all that. Is there
enough nets supply to make any difference in terms of
(29:26):
your forecast for next year?
Speaker 3 (29:28):
And look, we agree on the one six one seven
is probably our base case, but there are market participants
investment banks that actually forecast closer to to trillion. You know,
I agree that given the size of the savings pools
globally and ability of US investors to move money from
money markets into further out the curve, absolutely there's more
(29:55):
than sufficient amount of resources to absorb that net issuance
in twenty However, that ability is dependent on broad macro
dynamic inflation dynamic FED dynamic cooperating as well. So if
we have a benign Trump administration, then placing one and
(30:16):
a half or two trillion of paper should not be
a problem for these markets. And actually that's been one
of the big surprises of this year, as we were
running issuance that was thirty forty percent ahead of estimates
and last year's numbers. None of the periods of heavy
issuance led to any meaningful indigestion from a spread perspective.
(30:38):
So clearly there was a lot of money being put
to work in anticipation of raidcuts ahead. But if you
take away that expectation of radcuts ahead and add to
that all the volatility associated with the new administration and
policymics being reflected in FED thinking as well, then placing
all that paper might become might become more difficult, and
(31:03):
the clearing level for all this supply could necessitate wider spreads.
There have been multiple periods in recent years where, for example,
when we had the spike in issuance to do with
M and A, something that very much could be the
case in twenty twenty five, as we see deregulation and
less objection from this administration to MNA activities, the clearing
(31:26):
level for getting these deals done in the market could
mean wider spreads. We have not been used to that
for a while, but there were clearly multiple environments in
recent years where market demanded more spread and was getting
more spread when all that M and A pipeline had
to be funded.
Speaker 2 (31:43):
Pivoting maybe contrary to some sector sector views, maybe across
ig and maybe split it between high yield. Do you
have you know, favorable sectors that you look upon as
you know a performing Maybe in twenty twenty five, I
think about MySpace and high your healthcare twenty twenty three
is a real bad year for a lot of people,
A lot of analysts switch seats.
Speaker 3 (32:02):
You know.
Speaker 2 (32:03):
Twenty twenty four has been much better, largely driven by
improvement on hospitals and bouch Health and some other names
but you know, obviously the headline risk entered the room
with the new administration has muddeled the picture a bit.
For health care, I wonder maybe away from the healthcare
views or you know, across this high yield and investment,
(32:23):
what are some sectors that might stand out to you
as being particularly favorable or unfavorable.
Speaker 3 (32:29):
Well, well, look at that through the lens of idiosyncratic
factors for that sector, so whether the narratives or twenty
five could be positive or not. But also valuations, there
are a lot of good sectors out there that that
trading at multi tight, So it's very difficult for me
to suggest to our clients that that is an attractive
area to put money to work. Whether there's literally no
(32:53):
spread upsite from our perspective. So when it comes to
investment grade, there are not that many pockets at this
stage where we see a lot of value left. Financials
still have pockets that look good, and the new administration
should be broadly quite positive for financials. So whether it's
(33:16):
money center banks or regional banks or more slightly more
esoteric financials, the new insurance platforms that are starting to
find more aggressively.
Speaker 4 (33:27):
We see a fair.
Speaker 3 (33:29):
Amount of value there, but clearly less than was the
case a year ago.
Speaker 4 (33:36):
When it comes to other.
Speaker 3 (33:39):
Sectors, we see value in TMT, but mainly in technology
and media because those are areas where investors have a
very strong disagreement in terms of direction of travel for
those sectors, when we're talking about broadcasting, when we're talking
about chip manufacturing. We love stories where there's a broad
(34:01):
disagreement in the market about the direction of travel because
that creates opportunities further down the line, and those are
one of the few that still have upside potential compared
to other alternatives. So I would highlight those two areas
as ones of focus for ourselves. What we don't like
(34:25):
in investment grade are essentially the tightest sectors that are
giving very little protection to investors.
Speaker 4 (34:31):
So whether you're looking at.
Speaker 3 (34:34):
Consumer staples or I'm sorry, Mike, healthcare, there is very
little left on the table.
Speaker 2 (34:41):
I'm looking at un h spreads on a five year
CDX CDs are at forty you know, elevance the payers,
not that CDs is an accurate market, but you know,
those spreads are really tight.
Speaker 3 (34:52):
In my view, yes, we would agree that there's not
much left on the table there, but actually, we also
think that cyclical are too expensive as well. So with
the exception of autos, which is one sector that has
repriced wider in recent weeks. And you know, even though
the pressures have been felt much more on the European
(35:13):
side than on the US side, that is one sector
that consistently trades wider because of heavy regular issuance. The
rest of the cyclicals to US looks very expensive, and
that universe is taking advantage of the fact that we've
seen limited issuance over the recent quarters. But we don't
(35:37):
really want to take the downside risks of that universe
on board and stay away from many capital goods, heavy
industrials names in the investment grade space. On the high
out side, the situation is a bit different because yes,
actually financials are also one of the more attractive asset classes.
(35:59):
But that's where parallels end, and the benefit for financials
in high yield is to do with the fact that
it's actually growing growing portion of the high old universe.
Financials used to be the kind of more esoteric falling
between the cracks part of US high old bond universe,
(36:19):
but we've seen a lot more issuance in various manifestations
of financials in high yield, and that space has grown
and that space has become more interesting. But away from that,
where we see value is across a broader range of issuers,
(36:40):
because some more growth sensitive issuers, but those that are
very focused on the US to look well positioned for
this new administration, for the benefits of lower taxes and
the regulation. So actually we're happy to dible thet out there.
We also like segments of the TMT market that are
(37:03):
less represented in investment grades. So for example, not all
but some investments on the satellite site, and I know
it's a painful sector for any highield investor looking over
the recent years, but we do see opportunities. They're differentiating
between the haves and have not. And finally, we also
(37:26):
see really interesting situations in some of those binary co
op stories that I mentioned earlier. In some circumstances, the
balance of risks between positive negative outcome is really pointing
towards being long those securities, whereas in other cases it's
more of a coin toss and you'd want.
Speaker 4 (37:47):
To avoid those.
Speaker 3 (37:48):
So highyield is in our opinion, much monuanced than the
case in investment grade. But there are also more opportunities
there to get to work. The final thing about high
field worth highlighting is because some of the strategies we
look after our global rather than us in nature that
there's a lot of value left on the table in
(38:10):
emerging market high yield space. So unlike in investment grade
where we find very little extra spread in investment grade
EM opportunities compared to develop market, once in high yield
there's a fair amount of value extra yield left on
the table for similar sectors, similar rated.
Speaker 4 (38:28):
Issuers within EM high yield.
Speaker 3 (38:30):
But you have to be cognizant there that you don't
operate in a vacuum, and you have to respect the
macro trends. So for example, recent developments in Brazil and
the trading of securities there have been heavily impacted by
the macro story. But generally speaking, if you're careful about
your selection in EM, if you don't get over your
(38:51):
skis and also recognize that in a higher for longer world,
that will not be a tailwind for EM assets. If
you carefully select opportunities there that could be a good
supplement to your high portfolio.
Speaker 1 (39:05):
And once that is clear, I mean if you have
any kind of long term plan. I'm sure you do,
but can you share with us in terms of you know,
what's the best thing for next year? Where's the best
relative value?
Speaker 3 (39:15):
Well, it depends what Trump administration does to us in
the first months of the year. But look, our view
and something that we've been telling our clients is that
once the dost settles, once we know exactly what the
policy mix is and what federal reserves response to that is,
it will be time to re engage.
Speaker 4 (39:36):
With the market.
Speaker 3 (39:37):
Because the global demand for US fixing comasets is tremendous
across various manifestations depending on your risk tolerance, all the
way from investment grade.
Speaker 4 (39:46):
To high yield.
Speaker 3 (39:47):
We do think there will be a ton of money
that will want to be put to work.
Speaker 4 (39:52):
At higher yield levels.
Speaker 3 (39:54):
And also reflecting on the fact that we are not
forecasting a recession in the US, we'll look at the
feedback from companies. We're looking at data across all of
the consumer cohorts and all that data still looks robust.
We're not seeing signs of any aggressive deterioration and that's
(40:14):
not our base case for.
Speaker 4 (40:17):
Next year. So with that in mind, once that.
Speaker 3 (40:22):
That settles and hopefully you have better entry points after
a period of volatility and maybe some risk transfer from
longer duration investors moving back to cash or shorter duration
assets that will create a good entry point that will
help propel strong, positive toll returns across the fixed income stack.
(40:43):
So that's really what we are positioning for. But we're
waiting it out first in shorter duration assets and then
ready to re engage once that policy clarity is gained.
Speaker 1 (40:53):
But there could be an outcome which isn't so positive,
And in which case do you think there'll be a
major shakeout if Trump doesn't turn out to be so
benign after all?
Speaker 3 (41:03):
Well, we're assuming that Trump not being benign is, in
our view, actually the more likely scenario rather than the
very benign expectation that the market has, So we do
expect fireworks in those first few months of the year.
But again, at the end of the day, we remember
that fundamentals of US economy are strong, and a lot
(41:25):
of the measures that could be worrying from a fixed
income perspective are actually often positive from equity perspective. So
when we're looking at lower taxes, deregulation, those should be
positive stimuli for the US and that is why, for
as long as we do not see recession as your
(41:46):
base case outcome, and it's definitely not our base case outcome,
we are happy to fade the noise, and once it
does settles, re engage with fixed income on a more
more broad basis. But yes, like we might be making
these decisions from a position where investors who entered the
(42:09):
year with the bullish sentiment are sitting on toll return
losses at that point, given move higher in treasury yields
and bond yields, But to us that eventually would be bought,
and it would be right to take advantage of those
better entry points given the broader, solid macro backdrop.
Speaker 1 (42:31):
Do you expect positive returns in both highield and investment
grade next year?
Speaker 4 (42:34):
Us?
Speaker 3 (42:35):
I think it's easier to make the case for positive
returns in high yield given you have less rate sensitivity
and you know the starting yield of the acid class. So,
in a similar way as we were sharing with our
clients this year, our confidence in positive returns in high
yield is higher than confidence in positive returns in investment grade.
(42:57):
And particularly speaking of investment grade, looking at twenty twenty five,
we see a small chance of flatish to negative returns,
but in most scenarios we still see positive positive returns.
Just to give you an example, we see a risk
of and we've been sharing that for quite some time now,
(43:17):
of thirty year hitting five percent over the coming months,
and that probably would imply high force for the ten
year from that initially would lead to negative returns for
your fixed income portfolio, but as the year progresses, taking
into account the carry off the acid class, we think
that will returns shoot tilt into positive territory. And if
(43:43):
the trade storms abate and inflation starts behaving again, the
prospect of rate cuts returns as well. So in that
world you could potentially have quite a boost to your
returns in the second half of the year. But first,
let's survive the first half and then talk about what
happens in a second.
Speaker 1 (44:03):
And do you worry it to all? I mean, I'm
interested in also Mike to feel on this, But do
you guys worry at all about the fact that there's
this weight of cash pushing down on not enough stuff
to buy in. There's such enthusiasm, such excitement, such a
biliance over a bulliance. You know, it's a to me,
it's it's smacks of complacency and setting us up for
trouble down the road. Do either of you worry about that?
Speaker 2 (44:21):
Andrew, it's been talking a lot, I would say, I've
been speaking with a lot of clients about that technical dynamic,
and I speak to a lot of healthcare loan analysts. Right,
so a lot of the loans that there's managing and
covering have been transitioning to the private credit space. There
was just a loan deal last year or last week
where Canpasses that was just it was just paid off
and then moved private. So it seems like there's just
(44:44):
a from what I can see, a lot of demand
for low rated paper and it's de risking on the
high yield market. So in a way by taking out
the risk of your assets, so that should be bullish
for high yield, all things.
Speaker 1 (44:57):
Equal, pushing the risk elsewhere, and that that's going to
bliw up and take us by surprise potentially.
Speaker 2 (45:02):
Well, I think it's more manageable, right when you go
to a private credit lender and a sponsor, you can
negotiate with each other and it's not that costly bankruptcy
attorneys in there, and you have to pay.
Speaker 1 (45:12):
An upbeat note.
Speaker 3 (45:13):
What about you, Andre, I do agree there's a lot
of complacency out there, and I find it disconcerting when
sitting at roundtable dinners, most people assume spreads will be
range bound and returns will be positive and everything will
end up well. In most years, it does, but it
doesn't always have to be this way, and this is
(45:35):
one of the other reasons why while we were running
quite positive regarding our risk exposures so quite long risk
into the election, we felt that following the election, as
the rally got even more turbo charged, that was the
right time to d risk. So across both investment grade
(45:56):
and high yield portfolios, we have reduced our exposure too
longer duration assets to those that have rallied the most,
and redeployed all of those sales into shorter maturity, shorter
duration alternatives where we can enjoy still historically high carry
and sit out the next few weeks until the policy
(46:20):
mix is clear. So we're very happy to offload some
of the bonds trading at multi tights to other investors
who are still really built up about this market. But
we feel there's a fair amount of complacency there. But Hey,
that'll just creates someone on the other side of the
(46:41):
phone who will take the block of bonds from you.
Speaker 1 (46:43):
Great stuff, Andrei skib ahead of US Fixed Income for
RBC Global Asset Management. It's been a pleasure having you
on the Credit Edge.
Speaker 4 (46:49):
Many thanks, thank you so much.
Speaker 1 (46:50):
All the best everyone, and of course to Mike Hollin
with Bloomberg Intelligence, thank you very much for being.
Speaker 4 (46:55):
On the show.
Speaker 2 (46:55):
Happy to be here, Thanks James.
Speaker 1 (46:56):
Bloomberg Intelligence is part of Bloomberg's research department, with five
one hundred analysts and strategists working across all markets. Coverage
includes over two thousand equities and credits, as well as
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(47:19):
tell your friends, or email me directly at Jcrombie eight
at Bloomberg dot net. I'm James Crombie. It's been a
pleasure having you join us again. Next time on the
Credit Edge.
Hello, and welcome to The Credit Edge, a weekly markets podcast.
My name is James Crombie. I'm a senior editor at Bloomberg.
This week, we're very pleased to welcome Andre Skiba, head
of US fixed Income for RBC Global Asset Management. How
are you, Andre, Very well, pleasure to be with you.
Thank you so much for joining us. Stay very excited
to have you on the show. Also delighted to have
back as our co host Mike Holland with Bloomberg Intelligence.
Speaker 2 (00:40):
Hello, Mike, Hey, James, Hey Andre, Great to be here.
Speaker 1 (00:43):
Great. So, just before we start talking, I just wanted
to say a few words about where we are now.
US markets are rallying as rates come down, the economy
keeps chugging along, and investors look forward to a new
US administration, which the bulls think will be very pro
grow and pro markets credit markets, and meanwhile on fire,
there's a ton of demand for yield. No one seems
(01:05):
to mind that bond spreads are the titus in twenty years,
but that doesn't mean there's no risk. The Fed is
cutting rates, but they are going much slower than most
people have been expecting, and treasury yields are stuck above
four percent, while the stated aims of the next government
all look very inflationary, signaling a period of higher for
longer interest rates, and that means elevated debt costs, which
(01:25):
will put borrowers in the weaker part of the market
in a difficult spot for next year. We've already seen
a ton of defaults and bankruptcies in private markets. There's
more mending and extending of bonds and loans, while some
lenders are having to get repaid with more debt, and
there's more of this so called payin kind activity, which
(01:47):
isn't always good news. And in the background, we have
a huge amount of geopolitical risk which will be amplified
by the Trump trade wars. Maybe that just makes US
assets even more compelling on a relative basis, but there's
seal potential for a lot more voldaceity across all credit markets.
So Andre, what does that mean for twenty twenty five?
Are you bullished for next year?
Speaker 3 (02:06):
Well, we expect a lot of volatility, So we bullish
on volatility coming and hitting us soon as the market
grapples with the new administration and the new policy mix.
But we do believe that eventually, once the dust settles
and investors understand what this administration is trying to achieve
(02:27):
and what is the response of the Federal Reserve and
FOMC to this new policy mix. Once the dust settles,
we do think people will re engage with fixed income
and will like historically attractive yields.
Speaker 1 (02:40):
But so, how does it take the dust settle? It
looks like there's a lot of dust coming. Is it
going to be years before we know what's going on?
Speaker 4 (02:47):
Oh, God forbid.
Speaker 3 (02:48):
We're hoping to have more clarity over the first few
months of the year, And to us, like the biggest
question is really to do with stands towards trade. During
the campaign, we've heard again and again the willingness to
consider ten percent tariffs on most trade partners and most
(03:09):
goods on top of tariffs regarding China, and if that
were to happen, it would have very negative implications both
in terms of inflation and fixed income in our opinion, If, however,
we get a more benign trade rhetoric playing through where
(03:31):
it's used as a transactional tool, for example, in the
context of questions about immigration, but there is no broader
escalation that has more of a global nature in that
world inflation is less likely to spike, and we do believe,
based on other conversations with people on the hill, people
(03:52):
in the incoming administration, that investors should have clarity which
of those two options incoming team chooses in the first
two three months of the year.
Speaker 2 (04:05):
Hey, Andre, it's my colin here. Looking across your funds managed,
seems like you had a really strong year, right, you know,
you look at investment great returns around six percent, some
high yield and loan funds up nine, you know, approaching
ten percent. If as you think about you know, you
mentioned volatility and being long, you know, maybe being long
vol Is there a way that you execute that view
(04:27):
in your funds? I mean, are you able to cross funds,
you know, express views, maybe through index options or other
ways to capitalize on that volatility expectation?
Speaker 3 (04:38):
Well from for most of the strategies that we manage
that benchmarked type strategies, the way to position for incoming
volatility is very simple. Reduce risk and rather than hedging
and wedging your portfolios adding layers of derivative protection, that
(05:01):
is a strategy that works for a short period of time.
But history shows again and again that if you want
to do risk, you need to sell bonds. If you
want to do risk, you need to reduce your exposure
to longer duration assets, and that is the best way
to weather any storms or pick up in volatility. So yes,
(05:21):
absolutely we see a role for the derivative solutions within
our strategies to address the spike in volatility, but it
can't be the main way to address that vole. The
main one is reduce risk, cut risk.
Speaker 1 (05:40):
What does the return of volatility mean for spreads under
in a You know, we're hearing some very aggressive calls
for spreads to keep going tighter because there's not enough
supply and more demand, and you know, people really don't
care that much about spres. They care more about yield.
So one of our guests suggested that the ig US
could go to fifty five basis points, which is the
since nineteen ninety seven, and then we are someone on
(06:02):
the high ould side. They said that, well, that would
mean that junk we'll go to two twenty five, which
has never been seen.
Speaker 3 (06:07):
It really depends on the environment we're going to have
ahead of us. If the more benign version of the
Trump administration happens and inflation does not see appward pressure,
which allows for the FED to cut rates. We do
believe there's an absolute ton of money that wants to
(06:27):
be put to work in further out the curve in
fixed income. Like we look at money market balances the
close to historical highs, So even if a fraction of
that goes into fixed income, it could have meaningful implications
for spreads. The same goes for foreign investors. We're hearing
again and again about the attractive level of yields in
(06:51):
US fixed income from our foreign clients. And even though
in some jurisdictions the hedging costs are a major issue,
there's still a ton of money to you put to work.
So yes, there is a possibility where in a very
benign trade scenario, in a world where, for example, the
new administration is successful in reducing deficit through all the
(07:15):
cost cutting measures that have been announced in that world,
spreads go aggressively tighter and a credit spread becomes just
a number. It just becomes a derivative of the heaviness
of flows coming into the asset class. But that is
clearly not our base case scenario. In our view, you
are much more likely to have a bit of a
(07:37):
wake up call for investors realizing that spreads don't just
go tighter ad infinitum, but actually there is such thing
as volatility. There is such thing as risk transfers that
push spreads wider as investors recognize a shift in the
policy mix and federal reserves posture towards the market. So
(07:59):
from our perspective, widening up spreads in the beginning of
the year, possibly even approaching one hundred basis points in
investment grade and definitely crossing three hundred basis points in
high yield is very much possible. So that that is
the scenario we're really positioning ourselves.
Speaker 2 (08:15):
Full that would be against the view that we had
at our big credit conference a couple of weeks ago,
when Matt Brill from Invesco was pointing out that fifty
five basis point target. You know, it did seem this
seems to be a lot of bullishness, and I tend to,
as a credit analyst by trade, be a little more
negative and concerns. So I share your views on that. Andre,
I would like to kind of move aside and ask
(08:37):
you a little bit about market technicals. And you know,
I grew up in Loanland as a credit analyst, and
then I moved on to bonds. I've covered, you know,
all sorts of different asset classes on the credit side,
and I wonder, you know, looking at the market today,
we've got something like twelve or thirteen billion of new
high field issuance in healthcare high old bonds, you know,
(08:57):
maybe eighteen billion or so of private credit Bloomberg's tract
of healthcare related issues, and then one hundred and twenty
one hundred and fifty depending on how you cut it,
of a billion of loans. So the high old bond
market structurally, it seems like it's getting smaller, right, And
some of the riskier deals, the sponsor back deals, are
going to private credit. And I wonder if you see
(09:19):
that as supportive to the market, despite the risks that
are rising every day, it seems do you see that
as supportive to the market, you know, in twenty twenty five,
maybe on high yield.
Speaker 4 (09:30):
It's definitely a possibility.
Speaker 3 (09:32):
Like when we speak to investors across the US, everyone
hates high yield. Everyone moans about the fact that spreads
are very tight by historical standards, and that is almost
the mantra that we're here again and again. Well in
a way that creates a positive technical because you have
no hot money coming into high yield at this time.
(09:55):
It also helps that flows have stabilized in the highl
while you still have money coming into private credit space.
So it has been absolutely helpful to have capital flowing,
whether into private credit or into leverage loan market to
help address idiosyncratic issues that could be plaguing our sectors.
(10:20):
So issuers find refinancing solutions in markets other than where
they started in. So you might have had a bond
that you need to address and instead of refinancing that
in the bond market, you could have opportunities, be it
in leverage loan or in a private credit space, and
that's definitely something that reduces the likelihood of a spike
(10:44):
in defaults across the entire leverage finance stack. And while
the technicals are quite favorable with issuance not being too
heavy most of the activity being to do with refinancing
rather than new that funded acquisitions for example, all that
(11:05):
creates a relatively positive backdrop for high yield. Having said that,
let's not fool ourselves, there will be pockets of the
market where the where investors will punish too much leverage
no cash flow in a higher for longer world, or
very aggressive structures that are struggling in an economy that
(11:30):
might be slowing down a bit.
Speaker 4 (11:32):
So I'm not.
Speaker 3 (11:33):
Saying that across the entire stack of high yield it
will be a party. Across twenty twenty five. There will
be pockets that will feel pretty ugly. But from our perspective,
the fact that companies have multiple avenues to address the issues,
in multiple markets to go to to address these issues,
while at the same time there's not like a wave
(11:54):
of hot money that has hit high yield that might
reconsider its decision, creates a relatively positive backdrop. It doesn't
mean that spreads can't go wider. It just means that
it's very difficult to imagine very ugly price action in
high yield over the coming quarters.
Speaker 1 (12:13):
You say, everyone hites high yeld, but that's done so
well in multiple seeds at fifteen percent this year, so
that must be attracting some of this kind of money.
Speaker 3 (12:21):
Now, well, that's the irony of the situation that the
market that has done the best out of the public
market was the one that throughout the entire year everyone
was moaning about spreads being at unattractive levels and only
yields looking relatively attractive by historical standards. We're not seeing
(12:41):
an avalanche of money coming in. We have noticed that
a fair amount of investments in high yielding assets have
gone into private credit space, and that has been the
main beneficiary over the recent years of flows, with high
yield kind of being a far distant second or third
(13:04):
beneficiary in that respect. So we're not really seeing that
dynamic change.
Speaker 1 (13:09):
And do you expect triple c is to continue to
perform at this level to make more double digit returns
next year?
Speaker 3 (13:16):
It's difficult to envisage that you're going to have such
strong performance as you had this year. And part of
the strong performance in twenty twenty four was to do
with investors' positioning for more economic weakness and more vulnerability,
whereas US has again shown to be so resilient and
that has primarily benefited triple C issuers. But it's fair,
(13:41):
it's fair to admit that even though there are a
lot of Triple C credits that are getting to valuations
where it's difficult to be excited and it's pretty much
of a glass half full version of events that is
priced in rather than the more conservative scenario. You also
have quite a lot of situations, especially those in vault
battles between bondholders and companies or bondholders and other debt holders,
(14:06):
where you have quite binary outcomes and many of those
triples rate that issuers could see meaningful either price appreciations
of the clients depending on how those battles play out.
So that is one corner of the market, the big
kind of co op structures and you know creditor and
on creditor violence and issue on creditor violence where binary
(14:30):
outcomes are still possible in twenty twenty five, that could
significant impact returns in triple C stack.
Speaker 2 (14:38):
Yeah, I mean if you look at Bouche Health, right,
we been talking about Bouche Health for a long time,
but you know, four years ago they talked about spinning
out Bauscham Home and really benefiting the equity holders of
that company to the detriment of bondholders. And it's been
a long road and they're still working on you know,
progress there, but it's been one of these the the
(15:00):
biggest contributors to you know, positive returns in the high
yield space, at least in high old healthcare. You know,
the bonds are up twenty thirty points the longer data
on securitage. The term loan is up something like eighteen
points this year. And I've had a lot of questions
from clients saying, you know, why does the co op
agreement drive a technical You know, there wasn't a ton
(15:21):
of fundamental change with BA or Bouschelt this year, right,
and if the bonds went.
Speaker 4 (15:25):
Up like that.
Speaker 2 (15:25):
A lot of folks are pointing to the co op
agreements saying, you know, if you're not trading and there's
folks picking off bonds on the side, you know, that's
just driving a positive technical And what does that look
like going forward? Is that something that co op agreements
is there's just the positive outcome of owning a bond
and going into an agreement like that. Is that something
that you've talked about with your investment committees or some
of your clients.
Speaker 3 (15:47):
Well, we see two sides of this coin. On one side,
it's not just a question about co ops. It's also
a question whether you investeering commits you have a COP
because you might end up having different a mix compared
to the rest of the group. So that brings about
question about size and how large exposure would you like
(16:08):
to have to a particular issuer, which also comes with
its downside. So that's first aspect to highlight often differing economics.
The other one is a lot depends on what is
the starting position that investors had in a particular issuer.
If you have a name that was quite unloved, where
(16:30):
investors were frustrated with management, financial policy and the outcome
for the credit, and you have a co op forming,
that can lead to a positive price action because the
likelihood of negotiating better outcomes increases. Having said that, we
have plenty of examples of co ops that happened in
(16:51):
situations where you had an issuer that was a consensual
long for the market, and instead of boosting the valuations
further when a co op formed, the effect was the opposite,
where the marginal bias of those securities have essentially evaporated
(17:12):
because everyone was already pregnant.
Speaker 4 (17:15):
With that risk.
Speaker 3 (17:16):
And and that meant that on the follow through from
the co op forming, you had weaker trading of the
security in the weeks that followed. So initial positioning in
the name actually drives quite a lot of that response
to co opforming.
Speaker 2 (17:36):
That makes a lot of sense. I wonder too, though
you know you've been doing this a while, when you
see a co op agreement or the rise and co
op agreements like we've seen in the last several years,
do you think that's indicative of sort of a trend
toward away from syndicated bonds. If you have to negotiate
(17:57):
with a bunch of you know, bond holders that previous
we could pit against each other, and now they're operating
as one unit more or less, why not just go
to the private debt market going forward?
Speaker 3 (18:08):
I can see the attraction of that, and I agree
that having group of debtholders at sometimes diverging interest because,
for example, some of the holders could be in secured
part of the capital structure, some could be in the
unsecured part of the capital structure, and the objectives could
be different, and sometimes it's the same institution that has
(18:30):
holdings in both. That makes for a more complicated setup,
whereas reverting to a private market solution could be neater
for issuers going forward. And indeed, we actually have seen
examples of idiosyncratic stories where issuers facing pretty tricky circumstances
(18:54):
or a story that is not the easiest for the
market to absorb when down the route of private credit
rather than staying in the public markets to address the need,
so that trend can easily continue.
Speaker 4 (19:05):
And also it's.
Speaker 3 (19:07):
Fair to admit that for as long as money keeps
flowing into the private credit space, into the direct lending
private credit space, that market will have an incentive to
absorb some of those situations from public space, as all
this money is competing for opportunities to be invested into.
Speaker 1 (19:25):
On the private side. Andre we're talking about a twenty
trillion dollar market now that doubles in size over the
next five years potentially, according to one of our guests,
does that mean a great opportunity for you? I mean,
in terms of the investor proposition, what we're being told
is that it's much more return and much less risk.
Speaker 3 (19:44):
Well to us, it really depends on which corner of
the private credit space you're looking at, because you know,
when we're looking at that universe and you consider asset
classes like infrastructure, distressed investing, special situations, all those are
perfectly legitimate, very interesting areas that can easily grow and flourish.
(20:06):
Where we had concern over the recent years is in
the direct lending private credit space. Because to us, especially
when looking at an environment where higher for longer could
very much be the mantra for central bank in the
US that has meaningful negative implications for that asset class
(20:29):
when you think about this excluding ad backs, because that
is something that is very prevalent within the space. But
if you exclude ad backs and look at pure kind
of cash profitability, mid market leverage is running at six
and a half seven times, and when you're paying at
current level of rates, kind of double digit cost of funding,
(20:54):
you can straight away make a calculation that three quarters
of your EBITDA goals just to service your interest costs
before you spend any money on capex, on working capital,
on whether you have any tax obligations. So we see
a situation where structurally you have a space with very
little if any cash flow being generated, and that is
(21:17):
something that can last for a little while, but it's
not something that can be last for a multi year period.
And if indeed we staying a higher for longer in
the US because inflation remains sticky, we do see worries
about that space having very little financial flexibility, where most
(21:40):
of the issuers suffer the same problems of dealing with
double digit cost of funding with little cash flow to
show for, and you know, then you start thinking from
the perspective of privatecor responses in specific situations. Yes, you
can write a check and help to bail out a
(22:00):
particular issue or kick the can down the road. However,
if you're seeing that dynamic across your entire portfolio, then
you're going to be asking yourself twice, Okay, what kind
of an echo check did I write in the first place?
Have I already taken distributions from this investment? And if
the answer is yes, then why should I deal with
(22:20):
that problem that holders might have to deal with the
fallout from such circumstances. So we are concerned about how
direct lending private credit space would deal with a higher
for longer world where US economy is slowing down at
(22:40):
the same time, and absolutely there could be growth in
the future, but in the very near term that particularly
corner of the private credit space, we have a lot
of concern about.
Speaker 1 (22:52):
Do you think there'll be a lot more defaults there?
Speaker 4 (22:55):
Well, we're already seeing.
Speaker 3 (22:58):
Action to help address challenges that are happening at the
stage with the rise of the payment in kind usage
within the space, but it's not a permanent solution, so
that's more symptomatic of the problems that are happening there.
(23:18):
And yes, if we live in this higher for longer
world where instead of cutting rates, FED might have to
even consider potentially hiking rates, which is not our base
case scenario, but it's not outside of the realm of possibility,
especially if that aggressive trade war were to happen in
that world. Yes, there's definitely going to be more pain
(23:39):
across the direct lending private credit as a class, and
we absolutely believe that you're much better off in public
markets because the leverage profile, the interest cover ratios are
just so much better and a lot of those pressures
are far less acute.
Speaker 1 (23:58):
So across the board in private market, is you think
that there's there's more value in public even in the
sort of non distressed side of it, Well.
Speaker 3 (24:07):
We were generally observed that when you're looking at returns,
we're not calling for a dramatic wave of the faults
within the asset class, but when you consider relatively high
fees within those products, net of fees and net of
some selective restructurings that have to happen, we think, you know,
(24:28):
it's quite easy to make numbers work for a public
alternative with much more liquidity and much more ability to
reposition if you want to.
Speaker 4 (24:36):
So why take the risk?
Speaker 2 (24:38):
That's a good question. I wonder. You know, there's been
a lot of commentary about some of these private lenders
moving up the rating spectrum and participating in investment grade
financing is oftentimes their project finance. But what's your view
on that? I mean, I've been covering high yield for
a very long time, and I've been covering a lot
of the companies that were sponsored by you know, some
(24:59):
of these private equity now private debt shops that now
are looking into investment grade. I wonder what's your take
on that.
Speaker 3 (25:07):
Well, to us, it's really a function of how much
money has been invested in that space and that money
needs to be put to some use. And at the
same time, when you have very aggressive issuance in investment grade,
where some market observers are even estimating close to two
trillion that could be issued in twenty twenty five, that
(25:30):
would be on the higher end of the market expectations,
but that would be a huge increase compared to where
we were a few years ago. That creates opportunities for
some of money from other market segments to be put
to work, especially in slightly more complex moesoteric structures where
(25:51):
traditional investment grade investors are not as keen to a
jump on that bandwagon so much supply. Absolutely, it's opportunities
for money coming from various pockets to be put to work.
Speaker 4 (26:05):
Yeah, it strikes me.
Speaker 2 (26:06):
As a novel play where but like you said, if
you've raised enough money, you got to put it to work.
You're just going to expect lower returns over time. I
guess stepping back a little bit, you know, that's an
opportunity I guess for those those shops that are doing that.
But you know, in your shop and when you're talking
with investment committees, going from opportunities to risks, back to risks,
(26:28):
what are the two or three you know? I mean,
we have a lot of geopolitical risks, We have issues
across the board. What are the two or three that
are top of mind for you guys right now with
your investors, with your investment committees.
Speaker 3 (26:42):
Well, I think the number one question that we're being
asked by our clients and prospect is what kind of
a rate cycle will we have in twenty twenty five?
Because that, depending on your risk appetite, will drive total
return outloads across fixed income.
Speaker 4 (27:02):
If you're looking.
Speaker 3 (27:03):
At high yield assets, then you're less reliant on what's
happening in the rate world. You know, your double B
assets are definitely more sensitive to that, but across how
other parts of the rating stack you are less vulnerable.
And you know that's one of the reasons why here
to date HYLD has done better than high grade in
(27:24):
this respect, but particularly for investment grade investors, when you're
looking at projections of total returns, actually it's far less
your decision about where spreads will be over the course
of the twenty twenty five but more what level of
tenure treasuries will we have that will drive your total
(27:45):
return expectations. So that's clearly number one question that we get,
and in that context, to us, this question is absolutely
intertwined with a discussion about the new Trump administration policy mix,
especially when it comes to trade and how that's going
to play out in early months of next year. So
that's that's first order of business, and the other one
(28:10):
that we're also hearing quite a lot from investors is
questions about US exceptionalism.
Speaker 4 (28:17):
Is question whether given.
Speaker 3 (28:21):
Broad malaise in so many other parts of the world
where enthusiasm about any growth recovery is diminishing fast. Even
in China, where we had this burst of optimism a
few weeks back, quite a bit of that is already fading.
Can US maintain an edge over other parts of the world,
(28:44):
and does that also mean that valuations of US assets
will be will remain at the premium compared to some
of the offshore alternatives, so that that whole idea of
US exceptionalism and continue in that story. Can continuing in
twenty twenty five is very much on top of investors' minds.
Speaker 1 (29:04):
When you look at issuance. Andrea Youman mentioned this two
trillion dollar investment grade number. You know, we're hearing more
like I know one point six. But still even if
it if it is a high gross, the net still
seems to be quite low. I mean, there's so much
refinancing going on, there's maturities and all that. Is there
enough nets supply to make any difference in terms of
(29:26):
your forecast for next year?
Speaker 3 (29:28):
And look, we agree on the one six one seven
is probably our base case, but there are market participants
investment banks that actually forecast closer to to trillion. You know,
I agree that given the size of the savings pools
globally and ability of US investors to move money from
money markets into further out the curve, absolutely there's more
(29:55):
than sufficient amount of resources to absorb that net issuance
in twenty However, that ability is dependent on broad macro
dynamic inflation dynamic FED dynamic cooperating as well. So if
we have a benign Trump administration, then placing one and
(30:16):
a half or two trillion of paper should not be
a problem for these markets. And actually that's been one
of the big surprises of this year, as we were
running issuance that was thirty forty percent ahead of estimates
and last year's numbers. None of the periods of heavy
issuance led to any meaningful indigestion from a spread perspective.
(30:38):
So clearly there was a lot of money being put
to work in anticipation of raidcuts ahead. But if you
take away that expectation of radcuts ahead and add to
that all the volatility associated with the new administration and
policymics being reflected in FED thinking as well, then placing
all that paper might become might become more difficult, and
(31:03):
the clearing level for all this supply could necessitate wider spreads.
There have been multiple periods in recent years where, for example,
when we had the spike in issuance to do with
M and A, something that very much could be the
case in twenty twenty five, as we see deregulation and
less objection from this administration to MNA activities, the clearing
(31:26):
level for getting these deals done in the market could
mean wider spreads. We have not been used to that
for a while, but there were clearly multiple environments in
recent years where market demanded more spread and was getting
more spread when all that M and A pipeline had
to be funded.
Speaker 2 (31:43):
Pivoting maybe contrary to some sector sector views, maybe across
ig and maybe split it between high yield. Do you
have you know, favorable sectors that you look upon as
you know a performing Maybe in twenty twenty five, I
think about MySpace and high your healthcare twenty twenty three
is a real bad year for a lot of people,
A lot of analysts switch seats.
Speaker 3 (32:02):
You know.
Speaker 2 (32:03):
Twenty twenty four has been much better, largely driven by
improvement on hospitals and bouch Health and some other names
but you know, obviously the headline risk entered the room
with the new administration has muddeled the picture a bit.
For health care, I wonder maybe away from the healthcare
views or you know, across this high yield and investment,
(32:23):
what are some sectors that might stand out to you
as being particularly favorable or unfavorable.
Speaker 3 (32:29):
Well, well, look at that through the lens of idiosyncratic
factors for that sector, so whether the narratives or twenty
five could be positive or not. But also valuations, there
are a lot of good sectors out there that that
trading at multi tight, So it's very difficult for me
to suggest to our clients that that is an attractive
area to put money to work. Whether there's literally no
(32:53):
spread upsite from our perspective. So when it comes to
investment grade, there are not that many pockets at this
stage where we see a lot of value left. Financials
still have pockets that look good, and the new administration
should be broadly quite positive for financials. So whether it's
(33:16):
money center banks or regional banks or more slightly more
esoteric financials, the new insurance platforms that are starting to
find more aggressively.
Speaker 4 (33:27):
We see a fair.
Speaker 3 (33:29):
Amount of value there, but clearly less than was the
case a year ago.
Speaker 4 (33:36):
When it comes to other.
Speaker 3 (33:39):
Sectors, we see value in TMT, but mainly in technology
and media because those are areas where investors have a
very strong disagreement in terms of direction of travel for
those sectors, when we're talking about broadcasting, when we're talking
about chip manufacturing. We love stories where there's a broad
(34:01):
disagreement in the market about the direction of travel because
that creates opportunities further down the line, and those are
one of the few that still have upside potential compared
to other alternatives. So I would highlight those two areas
as ones of focus for ourselves. What we don't like
(34:25):
in investment grade are essentially the tightest sectors that are
giving very little protection to investors.
Speaker 4 (34:31):
So whether you're looking at.
Speaker 3 (34:34):
Consumer staples or I'm sorry, Mike, healthcare, there is very
little left on the table.
Speaker 2 (34:41):
I'm looking at un h spreads on a five year
CDX CDs are at forty you know, elevance the payers,
not that CDs is an accurate market, but you know,
those spreads are really tight.
Speaker 3 (34:52):
In my view, yes, we would agree that there's not
much left on the table there, but actually, we also
think that cyclical are too expensive as well. So with
the exception of autos, which is one sector that has
repriced wider in recent weeks. And you know, even though
the pressures have been felt much more on the European
(35:13):
side than on the US side, that is one sector
that consistently trades wider because of heavy regular issuance. The
rest of the cyclicals to US looks very expensive, and
that universe is taking advantage of the fact that we've
seen limited issuance over the recent quarters. But we don't
(35:37):
really want to take the downside risks of that universe
on board and stay away from many capital goods, heavy
industrials names in the investment grade space. On the high
out side, the situation is a bit different because yes,
actually financials are also one of the more attractive asset classes.
(35:59):
But that's where parallels end, and the benefit for financials
in high yield is to do with the fact that
it's actually growing growing portion of the high old universe.
Financials used to be the kind of more esoteric falling
between the cracks part of US high old bond universe,
(36:19):
but we've seen a lot more issuance in various manifestations
of financials in high yield, and that space has grown
and that space has become more interesting. But away from that,
where we see value is across a broader range of issuers,
(36:40):
because some more growth sensitive issuers, but those that are
very focused on the US to look well positioned for
this new administration, for the benefits of lower taxes and
the regulation. So actually we're happy to dible thet out there.
We also like segments of the TMT market that are
(37:03):
less represented in investment grades. So for example, not all
but some investments on the satellite site, and I know
it's a painful sector for any highield investor looking over
the recent years, but we do see opportunities. They're differentiating
between the haves and have not. And finally, we also
(37:26):
see really interesting situations in some of those binary co
op stories that I mentioned earlier. In some circumstances, the
balance of risks between positive negative outcome is really pointing
towards being long those securities, whereas in other cases it's
more of a coin toss and you'd want.
Speaker 4 (37:47):
To avoid those.
Speaker 3 (37:48):
So highyield is in our opinion, much monuanced than the
case in investment grade. But there are also more opportunities
there to get to work. The final thing about high
field worth highlighting is because some of the strategies we
look after our global rather than us in nature that
there's a lot of value left on the table in
(38:10):
emerging market high yield space. So unlike in investment grade
where we find very little extra spread in investment grade
EM opportunities compared to develop market, once in high yield
there's a fair amount of value extra yield left on
the table for similar sectors, similar rated.
Speaker 4 (38:28):
Issuers within EM high yield.
Speaker 3 (38:30):
But you have to be cognizant there that you don't
operate in a vacuum, and you have to respect the
macro trends. So for example, recent developments in Brazil and
the trading of securities there have been heavily impacted by
the macro story. But generally speaking, if you're careful about
your selection in EM, if you don't get over your
(38:51):
skis and also recognize that in a higher for longer world,
that will not be a tailwind for EM assets. If
you carefully select opportunities there that could be a good
supplement to your high portfolio.
Speaker 1 (39:05):
And once that is clear, I mean if you have
any kind of long term plan. I'm sure you do,
but can you share with us in terms of you know,
what's the best thing for next year? Where's the best
relative value?
Speaker 3 (39:15):
Well, it depends what Trump administration does to us in
the first months of the year. But look, our view
and something that we've been telling our clients is that
once the dost settles, once we know exactly what the
policy mix is and what federal reserves response to that is,
it will be time to re engage.
Speaker 4 (39:36):
With the market.
Speaker 3 (39:37):
Because the global demand for US fixing comasets is tremendous
across various manifestations depending on your risk tolerance, all the
way from investment grade.
Speaker 4 (39:46):
To high yield.
Speaker 3 (39:47):
We do think there will be a ton of money
that will want to be put to work.
Speaker 4 (39:52):
At higher yield levels.
Speaker 3 (39:54):
And also reflecting on the fact that we are not
forecasting a recession in the US, we'll look at the
feedback from companies. We're looking at data across all of
the consumer cohorts and all that data still looks robust.
We're not seeing signs of any aggressive deterioration and that's
(40:14):
not our base case for.
Speaker 4 (40:17):
Next year. So with that in mind, once that.
Speaker 3 (40:22):
That settles and hopefully you have better entry points after
a period of volatility and maybe some risk transfer from
longer duration investors moving back to cash or shorter duration
assets that will create a good entry point that will
help propel strong, positive toll returns across the fixed income stack.
(40:43):
So that's really what we are positioning for. But we're
waiting it out first in shorter duration assets and then
ready to re engage once that policy clarity is gained.
Speaker 1 (40:53):
But there could be an outcome which isn't so positive,
And in which case do you think there'll be a
major shakeout if Trump doesn't turn out to be so
benign after all?
Speaker 3 (41:03):
Well, we're assuming that Trump not being benign is, in
our view, actually the more likely scenario rather than the
very benign expectation that the market has, So we do
expect fireworks in those first few months of the year.
But again, at the end of the day, we remember
that fundamentals of US economy are strong, and a lot
(41:25):
of the measures that could be worrying from a fixed
income perspective are actually often positive from equity perspective. So
when we're looking at lower taxes, deregulation, those should be
positive stimuli for the US and that is why, for
as long as we do not see recession as your
(41:46):
base case outcome, and it's definitely not our base case outcome,
we are happy to fade the noise, and once it
does settles, re engage with fixed income on a more
more broad basis. But yes, like we might be making
these decisions from a position where investors who entered the
(42:09):
year with the bullish sentiment are sitting on toll return
losses at that point, given move higher in treasury yields
and bond yields, But to us that eventually would be bought,
and it would be right to take advantage of those
better entry points given the broader, solid macro backdrop.
Speaker 1 (42:31):
Do you expect positive returns in both highield and investment
grade next year?
Speaker 4 (42:34):
Us?
Speaker 3 (42:35):
I think it's easier to make the case for positive
returns in high yield given you have less rate sensitivity
and you know the starting yield of the acid class. So,
in a similar way as we were sharing with our
clients this year, our confidence in positive returns in high
yield is higher than confidence in positive returns in investment grade.
(42:57):
And particularly speaking of investment grade, looking at twenty twenty five,
we see a small chance of flatish to negative returns,
but in most scenarios we still see positive positive returns.
Just to give you an example, we see a risk
of and we've been sharing that for quite some time now,
(43:17):
of thirty year hitting five percent over the coming months,
and that probably would imply high force for the ten
year from that initially would lead to negative returns for
your fixed income portfolio, but as the year progresses, taking
into account the carry off the acid class, we think
that will returns shoot tilt into positive territory. And if
(43:43):
the trade storms abate and inflation starts behaving again, the
prospect of rate cuts returns as well. So in that
world you could potentially have quite a boost to your
returns in the second half of the year. But first,
let's survive the first half and then talk about what
happens in a second.
Speaker 1 (44:03):
And do you worry it to all? I mean, I'm
interested in also Mike to feel on this, But do
you guys worry at all about the fact that there's
this weight of cash pushing down on not enough stuff
to buy in. There's such enthusiasm, such excitement, such a
biliance over a bulliance. You know, it's a to me,
it's it's smacks of complacency and setting us up for
trouble down the road. Do either of you worry about that?
Speaker 2 (44:21):
Andrew, it's been talking a lot, I would say, I've
been speaking with a lot of clients about that technical dynamic,
and I speak to a lot of healthcare loan analysts. Right,
so a lot of the loans that there's managing and
covering have been transitioning to the private credit space. There
was just a loan deal last year or last week
where Canpasses that was just it was just paid off
and then moved private. So it seems like there's just
(44:44):
a from what I can see, a lot of demand
for low rated paper and it's de risking on the
high yield market. So in a way by taking out
the risk of your assets, so that should be bullish
for high yield, all things.
Speaker 1 (44:57):
Equal, pushing the risk elsewhere, and that that's going to
bliw up and take us by surprise potentially.
Speaker 2 (45:02):
Well, I think it's more manageable, right when you go
to a private credit lender and a sponsor, you can
negotiate with each other and it's not that costly bankruptcy
attorneys in there, and you have to pay.
Speaker 1 (45:12):
An upbeat note.
Speaker 3 (45:13):
What about you, Andre, I do agree there's a lot
of complacency out there, and I find it disconcerting when
sitting at roundtable dinners, most people assume spreads will be
range bound and returns will be positive and everything will
end up well. In most years, it does, but it
doesn't always have to be this way, and this is
(45:35):
one of the other reasons why while we were running
quite positive regarding our risk exposures so quite long risk
into the election, we felt that following the election, as
the rally got even more turbo charged, that was the
right time to d risk. So across both investment grade
(45:56):
and high yield portfolios, we have reduced our exposure too
longer duration assets to those that have rallied the most,
and redeployed all of those sales into shorter maturity, shorter
duration alternatives where we can enjoy still historically high carry
and sit out the next few weeks until the policy
(46:20):
mix is clear. So we're very happy to offload some
of the bonds trading at multi tights to other investors
who are still really built up about this market. But
we feel there's a fair amount of complacency there. But Hey,
that'll just creates someone on the other side of the
(46:41):
phone who will take the block of bonds from you.
Speaker 1 (46:43):
Great stuff, Andrei skib ahead of US Fixed Income for
RBC Global Asset Management. It's been a pleasure having you
on the Credit Edge.
Speaker 4 (46:49):
Many thanks, thank you so much.
Speaker 1 (46:50):
All the best everyone, and of course to Mike Hollin
with Bloomberg Intelligence, thank you very much for being.
Speaker 4 (46:55):
On the show.
Speaker 2 (46:55):
Happy to be here, Thanks James.
Speaker 1 (46:56):
Bloomberg Intelligence is part of Bloomberg's research department, with five
one hundred analysts and strategists working across all markets. Coverage
includes over two thousand equities and credits, as well as
outlooks on more than ninety industries and one hundred market indices,
currencies and commodities. Please do subscribe wherever you get your podcasts.
We're on Apple, Spotify, on all other good podcast providers,
including the Terminal at bpod Go. Give us a review,
(47:19):
tell your friends, or email me directly at Jcrombie eight
at Bloomberg dot net. I'm James Crombie. It's been a
pleasure having you join us again. Next time on the
Credit Edge.
Host
James Crombie
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