Index Investing News
Saturday, May 24, 2025
No Result
View All Result
  • Login
  • Home
  • World
  • Investing
  • Financial
  • Economy
  • Markets
  • Stocks
  • Crypto
  • Property
  • Sport
  • Entertainment
  • Opinion
  • Home
  • World
  • Investing
  • Financial
  • Economy
  • Markets
  • Stocks
  • Crypto
  • Property
  • Sport
  • Entertainment
  • Opinion
No Result
View All Result
Index Investing News
No Result
View All Result

Stressed and Distressed Credit: Risk and Reward

by Index Investing News
June 21, 2023
in Investing
Reading Time: 5 mins read
A A
0
Home Investing
Share on FacebookShare on Twitter


What is the current outlook for investors in today’s credit market?

Interest rates had been in secular decline since the 1980s. In the aftermath of the global financial crisis (GFC), rates hovered near zero as central banks embraced quantitative easing (QE) and flooded markets with liquidity. Among other effects, these monetary policies elevated the valuations of most assets, including private and public debt.

This trend came to an end in 2022 when central banks began to raise rates and tighten credit conditions to tame inflation. Today, investors must navigate this transition. In terms of economic expression — and to take a page from Thomas Piketty — we have shifted from an r > g to an i > g world, from one where the real rate of return exceeds the rate of economic growth to one where nominal interest rates outpace the rate of economic growth.

This has significant implications for debtors whose earnings are likely to grow slower than the interest accumulated on borrowed funds. As our parents might say, this is likely to “end in tears.”

Simply put, many businesses and investments have not been tested. Since 2009, save for a brief period in early 2020, nominal growth has outpaced nominal rates. Warren Buffett famously said, “You only find out who is swimming naked when the tide goes out.” Well, the tide is going out and as businesses refinance at higher rates, default rates and distressed exchanges are likely to rise concomitantly.

When revenue grows more slowly than the cost of financing, especially over an extended period, businesses feel the pinch. Add to this the large amount of US corporate fixed-rate debt coming due in the next couple years and banks and other traditional lenders getting cold feet, among other factors, and many businesses will be left vulnerable. Some are rolling over debt early, even at higher rates, to avoid potentially not being able to do so at all later on. Costs for high-yield borrowers are hovering near 9%. For investors, the risk focus has shifted from the rising cost of capital to refinancing, period.

Year to date, total US corporate bankruptcies have been at their highest level since 2010. The pace of defaults is expected to continue if not increase in 2023 and 2024 due to the lagged impacts of higher rates, slower economic growth, and inflation. This is not “business as usual.”

Investors’ risk appetite has also changed. While they may have felt compelled to venture further out on the risk continuum to capture yield, as the risk-free rate has increased, investors have less need to do so. The tumult in the US regional banking sector, with the March collapse of Silicon Valley Bank and Signature Bank and the failure of First Republic in May, has cast a pall over lending. A recent report on US economic activity showed a slowdown in job growth and a near-term deterioration of business prospects.

Tile for Gen Z and Investing: Social Media, Crypto, FOMO, and Family report

Where does that leave asset allocation in public and private credit? Rising rates have pushed bond prices down. Notwithstanding the ongoing love affair with private debt, there is an overlooked and growing opportunity set in the public debt markets that appear mispriced relative to risk and return. In 2020 and 2021, public and private debt was priced at par (or above) with private debt offering a liquidity premium in the form of a fat coupon. Today, the situation is different, with the edge going to the public markets. There are several reasons for this.

In the public debt market:

  • Pricing is determined in the open market and adjusted to changing market conditions.
  • There is greater price transparency. This brings more price volatility and more opportunities to acquire assets below par to increase the margin of safety.
  • Greater liquidity makes exiting a position easier should the risk/reward balance change or a better prospect for deploying capital develop.
  • Companies that issue public bonds have proven their business models in the market.
  • There is greater diversification of bonds in the public markets.
  • Public debt has corrected more than private debt in the rising interest rate environment.

In every economic cycle, some businesses with solid growth profiles will nevertheless carry some debt. For example, starting in 2015, the energy sector was severely stressed while other areas — hospitality, for example — were not. In 2020, amid peak COVID, hotels, movie theaters, and automobile rental services were struggling, but bakeries were doing fine. At some point, the prices in stressed sectors fell far enough that investors were compensated for the risk. Selective investors could find companies with high quality assets and strong competitive advantages. The occasional price volatility in publicly traded bonds offers the potential to exploit mispricing.

Data Science Certificate Tile

In the four previous default cycles, the average drawdown of lower-rated high yield was about 30% and the average recovery approximately 80% over the ensuing two years. With the high-yield bond market down roughly 18% in 2022, investors are beginning to see good opportunities developing in the eventual recovery in lower quality credits.

Investors looking to diversify their portfolios and take advantage of the valuation gap between public and private bonds should consider an allocation to public credits. Among an assortment of small to mid-sized companies lies an attractive risk-reward proposition. Due to their size, these companies experience greater capital scarcity and investors face lower competition from other capital providers. Further, as credit conditions remain tight and refinancing costs increase, more quality businesses will need to raise capital.

If you liked this post, don’t forget to subscribe to the Enterprising Investor.


All posts are the opinion of the author(s). As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©Getty Images / Tatomm


Professional Learning for CFA Institute Members

CFA Institute members are empowered to self-determine and self-report professional learning (PL) credits earned, including content on Enterprising Investor. Members can record credits easily using their online PL tracker.



Source link

Tags: CreditDistressedRewardriskstressed
ShareTweetShareShare
Previous Post

Episode #486: Ben Inker & Tom Hancock, GMO – The Value and Quality Opportunity – Meb Faber Research

Next Post

Stubborn UK inflation piles pressure on Bank of England to raise rates

Related Posts

Learn how to Maintain Tariffs from Derailing Your Renovations (Rookie Reply)

Learn how to Maintain Tariffs from Derailing Your Renovations (Rookie Reply)

by Index Investing News
May 23, 2025
0

The financial panorama is shifting quick. With tariffs driving up materials prices, does the BRRRR (purchase, rehab, hire, refinance, repeat)...

If No One Follows the 4% Rule, What IS the Proper Withdrawal Price?

If No One Follows the 4% Rule, What IS the Proper Withdrawal Price?

by Index Investing News
May 23, 2025
0

Most individuals assume the “protected withdrawal charge” for retirement (or early retirement) is 4%. However, if that’s the case, why...

98% of Housing Markets “Weaker” Than Final 12 months: Good Information for Traders?

98% of Housing Markets “Weaker” Than Final 12 months: Good Information for Traders?

by Index Investing News
May 22, 2025
0

The Downgrade Is Achieved. The Investor Response Is Simply Starting

The Downgrade Is Achieved. The Investor Response Is Simply Starting

by Index Investing News
May 22, 2025
0

For world traders and institutional asset managers, Moody’s downgrade of US sovereign debt is greater than a symbolic sign —...

No 401(okay)? No Downside—Sensible Retirement Methods for the Self-Employed

No 401(okay)? No Downside—Sensible Retirement Methods for the Self-Employed

by Index Investing News
May 22, 2025
0

Next Post
Stubborn UK inflation piles pressure on Bank of England to raise rates

Stubborn UK inflation piles pressure on Bank of England to raise rates

Ripple CTO: Federal Judges Echo Public Frustration Toward SEC

Ripple CTO: Federal Judges Echo Public Frustration Toward SEC

Leave a Reply Cancel reply

Your email address will not be published. Required fields are marked *

RECOMMENDED

.6 Million Homes in California

$1.6 Million Homes in California

December 28, 2023
Crypto space didn’t catch a break in 2022, seeing one implosion after another

Crypto space didn’t catch a break in 2022, seeing one implosion after another

December 24, 2022
Analysts Bullish On BTC Price Amid BlackRock, Fidelity Bitcoin ETF: Bloomberg

Analysts Bullish On BTC Price Amid BlackRock, Fidelity Bitcoin ETF: Bloomberg

June 28, 2023
New WA rules to protect homes from wildfire ignite controversy

New WA rules to protect homes from wildfire ignite controversy

October 31, 2023
Do I Have to Allow the Landlord to Do Building Repairs in My Apartment?

Do I Have to Allow the Landlord to Do Building Repairs in My Apartment?

March 16, 2024
Sam Bankman-Fried Appeals Conviction Only 2 Weeks after Sentencing

Sam Bankman-Fried Appeals Conviction Only 2 Weeks after Sentencing

April 15, 2024
Woman and two young children rescued from rubble of collapsed building in Turkey nine days after devastating earthquake

Woman and two young children rescued from rubble of collapsed building in Turkey nine days after devastating earthquake

February 15, 2023
Fannie And Freddie Get Green Light To Buy M Mortgages

Fannie And Freddie Get Green Light To Buy $1M Mortgages

November 30, 2022
Index Investing News

Get the latest news and follow the coverage of Investing, World News, Stocks, Market Analysis, Business & Financial News, and more from the top trusted sources.

  • 1717575246.7
  • Browse the latest news about investing and more
  • Contact us
  • Cookie Privacy Policy
  • Disclaimer
  • DMCA
  • Privacy Policy
  • Terms and Conditions
  • xtw18387b488

Copyright © 2022 - Index Investing News.
Index Investing News is not responsible for the content of external sites.

No Result
View All Result
  • Home
  • World
  • Investing
  • Financial
  • Economy
  • Markets
  • Stocks
  • Crypto
  • Property
  • Sport
  • Entertainment
  • Opinion

Copyright © 2022 - Index Investing News.
Index Investing News is not responsible for the content of external sites.

Welcome Back!

Login to your account below

Forgotten Password?

Retrieve your password

Please enter your username or email address to reset your password.

Log In