THIS TIME IT’S DIFFERENT
Despite investors taking on more risk and illiquidity, and in some cases moving up the leverage spectrum, industry experts are sanguine over whether the industry is slipping back into 2006 territory. It is generally believed banks are tightening their standards and those in the US and Europe continue to improve their overall credit quality. Many therefore think it is unlikely credit will trigger another financial market meltdown.
For M&G’s Lloyd there are strong structural headwinds preventing a slide into pre-crisis territory. However, the absolute game-changer, he adds, would be a pick-up in inflation driven by the ongoing retreat in globalisation.
He explains: “The thing we are watching very closely is any genuine retreat from globalisation and deregulation because one of the biggest single contributors to the low inflation environment has been globalisation. We are seeing fairly loud noises from the US and France beating a much more protectionist drum. It is a long way from the rhetoric to policies being delivered, but clearly that is a theme people holding fixed income securities should be watching.”
Pioneer Investments director of fixed income research and senior portfolio manager Michael Temple believes a downturn will occur at some point given the amount of money chasing the riskier part of the credit market, namely direct lending.
“How is that money going to leave and what effect will it have on the price of those securities?” he queries. “Even though there is not a tonne of leverage in the banking system it feels like leverage has been creeping up in the financial markets outside of that, particularly in China where you have had a tonne of lending away from the banks in the bond market.”
Temple adds leverage has been cranked up in direct lending and asset-backed securities, but not in the way people have been familiar with. As a result, in his multi-asset credit portfolio he has been taking some of the credit risk off the table by moving to the middle ground between triple-C at one end of the spectrum and triple-A or government bonds at the other.
“Moving to the middle – triple-B, double-B – we can get $500m to $1bn-plus in issue size so they are more liquid and have lower default expectations, and yet they have enough spread and yield to generate attractive income for people starved of income.”
But for Bluebay’s Riley, talk of entering another crisis is premature because pre-2008 investors were taking on much more disguised leverage which was presented as being very low risk. This led to big expansions in structured credit, collateralised debt obligations, asset-backed-type securities and most famously, of course, US subprime mortgages, which were highly rated but had a huge amount of embedded risk.
Summing up the current environment, he adds: “It is less evident you have excessive imbalances in the corporate sector or household sector.”
