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Public Fixed Income

IG Credit: Idiosyncratic Opportunities in a Favorable Environment

October 2024 – 3 min read

Given the combination of still-elevated yields, solid fundamentals and technicals, and a resilient U.S. economy, IG corporate credit looks well-positioned for the months ahead.

There are a number of tailwinds supporting the case for investment grade (IG) credit today. For one, yields in the U.S. remain compelling at 4.20%, which is 1.5 times higher than the 10-year average (Figure 1), while in Europe yields are at 3.2%.1 At the same time, recent data suggests the U.S. economy looks more robust than markets were initially thinking—and, as a result, the pace of rate cuts from the U.S. Federal Reserve (Fed) may be slower going forward. In addition, technicals remain robust, while recent data suggests a stabilizing picture on corporate fundamentals. While risks remain on the horizon—including the shifting macroeconomic and political backdrop and heightened geopolitical concerns—this backdrop suggests IG credit is well-positioned going forward.

Figure 1: IG Yields Remain Attractive

ig-credit-identifying-chart1.jpgSource: Bloomberg, Barings. As of September 30, 2024.

Supportive Fundamental & Technical Backdrop

From a fundamental standpoint, there have been signs of improvement across the market. In the U.S., revenue growth in the second quarter came through at 1.1%, while EBITDA was positive for the first time in five quarters at 1.1%.2 In particular, EBITDA ex-commodities rose by 7.1%, which is the fastest pace in two years.3 Meanwhile, net leverage, while higher on an annual basis, remained flat from the previous quarter at 2.9x, and interest coverage declined by 1.5x but remained in line with long-term averages.4 While CAPEX also increased, it was the slowest growth in three years, suggesting IG companies remain conservative in their approach to managing their balance sheets. The fundamental picture is similar in Europe—EBITDA rose 2.5% year-on-year, for instance, while net leverage is 2.7x.5 Adding to the strong credit story is the ratings profile of the market. In particular, the first half of this year saw roughly five times as many upgrades as downgrades—with the percentage of the IG universe rated BBB- at its lowest since 2012, and the single-A rated percentage at its highest since 2011.6

The technical picture also remains supportive. While new issuance has surpassed expectations, reaching $1.26 trillion in the U.S. year-to-date, it has been well absorbed by the market.7 For example, in terms of fund flows, inflows into U.S. IG funds this year have reached $260 billion compared to $182 billion of inflows in all of 2023 (Figure 2). Demand for IG corporate credit remains strong, particularly from yield-focused insurers, as they seek to match liabilities coming from surging demand for fixed annuities. That said, while yields are near their highest levels in the last decade, they are at their lowest levels in the past 18 months—and this has the potential to impact demand going forward. Nevertheless, following the Fed’s rate cut, we could also see some demand move out of money market funds and into corporate credit. At the same time, the recent policy changes from the Fed and the Bank of Japan have reduced hedging costs, making this asset class particularly appealing for buyers out of Asia.   

Figure 2: U.S. IG Fund Inflows Absorb Elevated Supply

ig-credit-identifying-chart2.jpgSource: Bloomberg Intelligence. As of August 31, 2024.

Idiosyncratic Opportunities & Crossover Credits

Spreads in IG credit remain tight overall compared to the start of the year, but given the high degree of dispersion among spreads, we continue to see attractive opportunities in the market. From a sector perspective, we see value in energy, which has been impacted by recent higher levels of volatility. In particular, new issues from midstream corporates look attractive. In addition, we continue to see opportunities in financials—albeit to a lesser extent than at the start of the year, given the significant spread tightening across the sector from banks to insurers to real estate investment trusts (REITs).

Looking across the market, some of the most interesting opportunities today, which we believe offer the potential for spread tightening, are of a more idiosyncratic nature. For example, we identified an opportunity in a manufacturer of computer components, which saw its spreads widen on the back of recent financial challenges and a ratings downgrade. Following positive news that the company signed a deal to manufacture AI chips, its spreads started to recover.

A key opportunistic theme we also like is in ‘crossover credits,’ which have generated 57% higher cumulative returns compared to the broader IG index and have outperformed the broader market in seven out of the last 10 years.8 These “rising stars” and “fallen angels” are companies poised for upward migration in credit ratings and those expected to see a downgrade from IG to high yield. In particular, rising stars tend to outperform a few months prior to upgrade. Here, we see select value in REITs and have identified an opportunity in a high yield-rated triple net lease corporate where the management team has expressed a desire to return to IG in the next couple of years. In our view, there could be some spread tightening if the company is upgraded.

Looking Ahead

The current backdrop is very favorable for IG credit. However, there are uncertainties on the horizon, from political to geopolitical risks, which have the potential to drive spreads considerably wider from current levels. With this in mind, while we believe there is a compelling case for IG credit going forward, taking a fundamental, bottom-up approach to investing—while being open to opportunistic and idiosyncratic opportunities—will be key.

1. Source: Bloomberg. As of September 30, 2024.
2. Source: J.P. Morgan. As of June 30, 2024.
3. Source: J.P.  Morgan. As of June 30, 2024.
4. Source: J.P. Morgan. As of June 30, 2024.
5. Source: J.P. Morgan.. As of June 30, 2024.
6. Source: J.P. Morgan (ex-EM issuers). As of September 30, 2024.
7. Source: J.P. Morgan. As of September 30, 2024.
8. Sources: Barings; Bloomberg. As of September 30, 2024.

Charles Sanford

Head of Investment Grade Credit

Stephen Ehrenberg

CFA, Managing Director

The document is for informational purposes only and is not an offer or solicitation for the purchase or sale of any financial instrument or service. The material herein was prepared without any consideration of the investment objectives, financial situation or particular needs of anyone who may receive it. This document is not, and must not be treated as, investment advice, investment recommendations, or investment research.

In making an investment decision, prospective investors must rely on their own examination of the merits and risks involved and before making any investment decision, it is recommended that prospective investors seek independent investment, legal, tax, accounting or other professional advice as appropriate.

Unless otherwise mentioned, the views contained in this document are those of Barings. These views are made in good faith in relation to the facts known at the time of preparation and are subject to change without notice. Parts of this document may be based on information received from sources we believe to be reliable. Although every effort is taken to ensure that the information contained in this document is accurate, Barings makes no representation or warranty, express or implied, regarding the accuracy, completeness or adequacy of the information.

Any forecasts in this document are based upon Barings opinion of the market at the date of preparation and are subject to change without notice, dependent upon many factors. Any prediction, projection or forecast is not necessarily indicative of the future or likely performance. Any investment results, portfolio compositions and/or examples set forth in this document are provided for illustrative purposes only and are not indicative of any future investment results, future portfolio composition or investments. The composition, size of, and risks associated with an investment may differ substantially from any examples set forth in this document. No representation is made that an investment will be profitable or will not incur losses. Where appropriate, changes in the currency exchange rates may affect the value of investments.

Investment involves risks. Past performance is not a guide to future performance. Investors should not only base on this document alone to make investment decision.

This document is issued by Baring Asset Management (Asia) Limited. It has not been reviewed by the Securities and Futures Commission of Hong Kong.

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