Edinburgh-based Standard Life Investments has told investors it expects another year of volatility in debt markets — and said it believes the risk of recession “is lower than the market is pricing in.”
The firm, which manages assets of more than £250 billion, said the current investment environment for debt securities is one of “selective opportunities.”
Craig MacDonald (pictured), head of credit for Standard Life Investments, said that amid the pressure on credit markets last year, “there was still considerable dispersion in regional performance and investment grade debt which provided selective opportunities for savvy investors.”
For example, MacDonald said European high yield debt outperformed US high yield, Sterling investment grade debt outperformed Euro investment grade, and Asian emerging market credit was “actually a strong performer” despite global concerns over China.
But in the fund company’s latest “Global Outlook” forecast, MacDonald warned: “However, there has been a weak and much more correlated start to 2016.
“Bank lending standards have tightened in emerging markets, and there are nascent signs of tightening in the US, although European lending is still loosening.
“Corporate leverage is relatively high in the investment grade sector, but remains lower than during the 1990s once the energy and commodity sectors are stripped out.”
MacDonald added: “US high yield was one of the worst performing credit markets in 2015 with a -5% return. Almost 50% of bonds produced negative returns and a number entered distressed levels.
“Just over 20% of US high yield names are in energy and commodities and therefore vulnerable to the fall in commodity prices.
“Distress has also been seen in retail and telecommunications, however, yields have widened out to 9%, leading to selective opportunities.”
MacDonald said that in US investment grade debt, good-quality issuers now looked cheap and while Standard Life Investments is avoiding some of the smaller regional US banks with over-exposure to commodities, “it is a different story for the large banks such as JP Morgan” which have strong balance sheets with low exposure to commodities.
“Another source of market worry has been emerging markets,” said MacDonald.
“However, Russian corporate credit had a very strong performance in 2015 despite Russia’s myriad of problems.
“And Chinese credit outperformed, particularly property bonds. The lesson is that there are opportunities as well as risks in EM credit.
“The upshot is that we expect another year of volatility in credit markets, and believe the risk of recession is lower than the market is pricing in.
“This is an environment of selective opportunities.
“In high yield during 2015, our funds benefited from a reduced exposure to the most risky CCC rated debt, but it is still too early to reverse this position despite the wider yields on offer.”