Investors keen to avoid the perils of timing the interest rate cycle can choose, instead of duration risk, to take additional credit risk.
That simply means buying bonds with a higher chance of default, a consequence of which is that most such bonds tend to be shorter duration by nature.
But how do bond investors and wealth managers assess credit risk?
A curiosity of bond markets in 2023 was that, despite the prevailing environment of low economic growth and persistent inflation, high-yield bonds performed relatively well.
Christian Hantel, senior portfolio manager for fixed income at Vontobel, says the strong performance of those assets in 2024 was more a function of new investors placing money into that part of the market, as he says they believed lower interest rates would make the yields more attractive and also be supportive of economic growth, which might be expected to reduce the risk of default by the companies borrowing the money.
But for Nicola Mai, economist at Pimco, the potentially better economic outlook in 2024 is not sufficiently enticing to justify taking additional credit risk right now.
He says: “We think there are higher macro risks than are priced in and we see resilience turning to stagnation. Therefore, when it comes to risk and risk assets we are cautious. Generic corporate credit is good in terms of interest rate risk, which anchors the valuations (and certainly the higher-quality names), while there is value in securitised assets.”
On the wider question of credit risk in a broad bond allocation, Mai says: “As we look at the global economy today, we see developed market economies that are expected to stagnate or slide into recession in 2024, and any economic slowdown will likely lead to rising credit stress and a higher number of defaults – an environment where active investors can thrive by managing credit risk from individual issuers rather than indiscriminately buying exposure to an index in the way passive investors typically do.
"Even in the high-yield area of the market, credit expertise, prudent risk management and a focus on downside avoidance can potentially result in a lower default rate than in a passive portfolio.”
Credit worthy?
Muzinich and Co fund manager Tatjana Castro says many investors have been chary of taking credit risk due to a negative perspective on the global economy.
But she adds that the relative yield offered on the bonds that have a lower credit rating than government bonds are presently attractive, and this is particularly the case within the investment-grade part of the market – that is bonds with a credit rating down to triple B.
She says she regards high-yield bonds as being correlated to equities, in terms of the levels of volatility to which an investor is exposed.
