Global capital markets have seen strong performance in 2023 despite the backdrop of economic challenges. What are the investment opportunities going forward? Why is fixed income corporate credit offering particularly attractive opportunities right now? I discussed these issues with a group of fixed income experts within Franklin Templeton. Here are my key takeaways from the discussion:
Move out of cash and into fixed income. While interest rates on cash are high, fixed income instruments provide similar yields with the added benefit of higher future total returns if interest rates decline. Given the current dynamics, the panel thought this was a good time to lock in current interest rates.
Corporate bonds show solid fundamentals. Current leverage, interest coverage, free cash flow and amortization schedules are at stronger levels than in the recent past. Focusing on higher-quality instruments allow portfolios to capitalize on generous current yields, income that could help weather economic storms should the economy weaken further than we expect.
Companies re-financed at low rates during the pandemic, avoiding the need to refinance at today’s higher rates. This may have contributed to the lower impact of the Federal Reserve’s rate hikes as companies do not need to refinance. Many companies may need to refinance by 2025, and thereafter, but we expect rates to decline before then.
High-yield bonds offer attractive total returns and better credit profiles than in the past. High-yield bonds may offer a bridge for investors between the typical risk/return profiles of fixed income and equity, with yields near 8.5% and some capital appreciation potential.1 In terms of improved quality, the proportion of issuers that are public companies has grown. This is important because they tend to manage their balance sheets more conservatively. In addition, the amount of secured high-yield debt has also risen.2
Private credit offers higher yields and lower correlations. Private credit providing a level of certainty and flexibility that banks can no longer offer has fueled corporate growth. A highly diversified pool of mostly senior secured loans generates strong risk-adjusted returns, with higher interest rates, lower leverage and tighter terms. Yields in private credit range from 11.5% to 12.5%,3 but investors must be able to bear illiquidity.
According to the panelists, interesting industries for opportunities include non-bank financials and select cyclical credit, including chemicals and homebuilders. Sectors to avoid include wireline telecom and mall-based retailers.
In conclusion, fixed income currently looks more attractive based on higher overall yields. Well-chosen, quality fixed income can add value beyond yield generation, benefiting from capital appreciation if there are future rate cuts.
This panel discussion was moderated by Stephen Dover, Chief Market Strategist and Head of Franklin Templeton Institute, and included Michael Buchanan, Deputy Chief Investment Officer and Head of Credit, Western Asset Management; Glenn Voyles, Director of Portfolio Management–Corporate Bonds, Franklin Templeton Fixed Income; Bill Zox, Portfolio Manager for High Yield and Corporate Credit Strategies, Brandywine Global; and Larry Zimmerman, Managing Director and Head of Private Debt Origination, Benefit Street Partners.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Equity securities are subject to price fluctuation and possible loss of principal.
Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Low-rated, high-yield bonds are subject to greater price volatility, illiquidity and possibility of default.
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1. Source: Bloomberg, as of August 4, 2023.
2. Source: Bloomberg, “Borrowers Flock to High Yield Bonds, Ditching Leveraged Loans,” August 3, 2023.
3. Source: Bloomberg, “Private Debt Unitranche Loan Index, Yield to Expected 3-Year Takeout,” July 24, 2023.