Key Themes for 2023: Investment Grade Credit
Investment Grade Credit
Jonathan Aal, Portfolio Manager, IG Credit
We have gone through one of the largest and quickest repricing of capital in the history of U.S. financial markets. As of December 13, 2022, investment grade corporate credit spreads are only 36bps wider YTD. A year ago, most of us would likely have said those two sentences should not come in sequence with the insinuation being greater spread widening would have been expected. This is not an unreasonable thought.
Despite the widespread repricing of money making its way into every nook and cranny of markets, broad based corporate fundamentals, balance sheets, credit quality, liquidity profiles, and maturity ladders have handled things well so far. This lends credence to why excess returns in credit did relatively well this past year reporting at -1.08% as of December 13, 2022.
As we peer into 2023, one thing we know for certain is the path forward will not chart a straight line. We need to consider the lagged effect of the 2022 monetary policy working its way through the 2023 economy and therefore the fundamental inputs to corporate and consumer credit profiles. Paired with current spread valuations, we should remain vigilant around the potential vulnerability of earnings and therefore spreads.
Since 2020, we have noted more sector dispersion when it comes to the position of varying businesses in the business cycle. This shouldn’t come as a big surprise as through the pandemic some companies thrived while others paused for varying periods of time. We bring this up as we look to 2023, because we would not be surprised to see business cycle dispersion become more evident in sector spread valuations. Having the credit expertise to correctly identify where a particular issuer is in its business cycle will be imperative to enhancing both security selection and avoidance.
We foresee the conversation around spreads versus yields, as it pertains to valuations, continuing to be meaningful; particularly in an environment where despite the increase of yields, durations remain elevated, specifically within investment grade. This leaves investors more exposed to changes in both credit and interest rate risk in both directions. While no prior period is a perfect analog for the future currently staring us in the face, we do believe all-in yields matter for credit investors. When yields are higher, this income has the potential to cushion against volatility and therefore increases the probability of realizing positive risk-adjusted returns. Ultimately, we believe both yields and spreads will be important.
Regardless of what future conditions materialize, we are confident that the path will not be straight, and the impact on individual company growth, earnings, and cash flows will be differentiated. As such, we will continue to fully exercise our active management nimbleness when it comes to portfolio construction and hunt for securities that may possess more attractive risk/reward profiles than the broader market.
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