Opinion Credit

Welshcake

Given January’s volatility and scary headlines, you may be reading this in a dour mood about what the rest of 2022 portends. But I’m here to reframe recent events as necessary hurdles on the long-awaited return to more normalised markets — even if they range from a fixed income apocalypse to actual World War Three.

The bearish views on credit I’ve found in 2022 outlook commentaries, would make it understandable if investors feel a bit like that woman holding the unopened but empty packet of crisps. Or like the UK’s prime minister, when the party is over and you didn’t even know you had it.

But fear not, credit can do well in 2022 even from a relative value perspective and despite the obvious headwinds. This is just a year to under-promise and over-deliver.

For starters, February will have better entry points. Credit began 2022 at crazy tight spreads, with a lack of fundamental differentiation. Frankly this necessitated a shake out — which uncertainty about inflation, treasury yields, soaring energy prices and the pace of Federal Reserve hikes have duly provided.

That’s not to say the job is done. Credit is still too rich and portfolio managers must differentiate themselves by finding pockets of value.

Primary markets will certainly be challenging for bond and loan funds. Borrowers will prefer to issue fixed rate to lock in debt costs ahead of expected hikes, which may appear to work against the interests of investors. But recent high yield issues point to a compensatory premium, especially since volatility can spike at any time.

The need for borrowers to explore strategies friendly to shareholders and growth means January’s slow roll-out will likely be a blip. M&A is very much part of the outlook and this bodes well for CLOs and loan funds, which also have floating rate on their side. Beta tracking is unlikely to work over the year, but fundamentals will stack up for high yield rising stars, energy transition pace-setters, cyclical credits and sectors that will benefit from reopening economies.

Expanding one’s instrument playbook is another way to be smart. Big credit managers increasingly intuit CDS will be a better way to position for rising rates than tying up capital through bonds — which of course is music to my ears. Index tranches and options can target relative value, while the returning CSO pipeline’s ESG focus holds promise on valuation, versatility and in defining industry standards.

All this said, market shocks from leftfield could define the year. Covid-19 has dropped down the list of concerns in many commentaries, and recent moves by firms — most notably Citi — to demand all staff be vaccinated shows resolve to bring the pandemic to an end. But it also reminds us that we are far from back to normality.

The new abnormal begins in Ukraine

The essay ends with Putin “confident that true sovereignty of Ukraine is only possible in partnership with Russia”, in a paragraph of friendly overtures which he acknowledges “can be interpreted in many possible ways”. Credit investors should interpret 100,000 Russian troops on the Ukrainian border as something worth pricing in, just as much as macro-economic factors.