Fixed income expert explains why response to crisis has provided a potential framework for next 12-15 months
Investors have been urged not to confuse yield spread with total return potential if they are to take advantage of a Fed-fuelled, post-pandemic sustainable rally in investment grade credit.
That’s the view of Norman Milner, managing director at Neuberger Berman, who runs a number of Purpose Investment’s core bond mandates, and who believes the fiscal, monetary and healthcare response to the pandemic has provided a framework moving forward from a risk and capital allocation perspective.
The liquidity squeeze in March and April sparked a response from central banks, with the Federal Reserve cutting rates to zero, moving into an aggressive bond-buying program and then taking the unprecedented step in buying U.S. investment-grade corporates along the lines of the ECB.
Milner said this “fantastic monetary protection” allowed the capital markets to begin its healing process, which was then reinforced by a massive fiscal response from the U.S. government. Add in the fact that the healthcare data then started to see a flattening of the curve and he believes this has created a clear line in the sand for investment grade fixed income.
He said: “Our perspective here is that we’ve seen the wides in investment-grade credit for now, and that unless we see an earth-shattering deterioration in healthcare data, we’ve probably seen the wides in that.
“Having said that, the opportunities on a go-forward basis, fixed income really doesn’t bring returns on a global basis. The actions of the Fed can’t be underestimated for what it does in buttressing liquidity solvency and the ability for people to take risks.”
With regards to the spreads, they are at historically wide levels. Milner explained that even after a tremendous rally, investment-grade spreads are still on or around 175 over to 200 over. Prior to the pandemic, they’d been trading in the range of around 100, which signals opportunity.
“What you see is the potential for roughly 75 basis points of tightening in the next 12 to 15 months,” he said. “Now, clearly much can go wrong, but if one assumes and begins to think about where investors will want to put capital to work, we have the potential for up to 75 basis points of rally in long-duration credit spreads across the curve.
“If you think about duration, and the impact that has on return, and long-duration in particular, which is a part of the market we’ve found to be incredibly attractive, you could end up with close to double-digit returns in the next 12 to 15 months in credit.
“That is probably one of the most missed opportunities because when people look at spreads they’re confusing the return potential with the spread compression. Our perspective is, frankly speaking, not a very aggressive one, but really much more benign in that we think to position to buy what the Fed is buying and putting ourselves in the position to benefit from those assets which are under the Fed umbrella and are shielded from the elements. That’s a very attractive place to be.”
Comparisons to 2008-09 are only natural, given that it was the last financial crisis and Milner said there are key differences this time that bode well for market recovery. The banks, widely vilified for their slow response to the housing crisis, appear to have learnt their lesson and moved quickly to ensure the liquidity crisis does not turn into a solvency crisis.
By encouraging firms to use the assistance they provided to access the debt markets to pay down their short-term debt, they have used their own robust balance sheets to store up the cash, which in turn encouraged the market.
“Companies proactively, defensively putting cash on to their balance sheets to prepare for what we can all recognize is the oncoming onset of a recession is a powerful and significant juxtaposition to what we had in ’08. It bodes well for the long-term recovery and, frankly, is a reason why we feel so good about some of the decisions we’re making in fixed income markets.”