Along with ‘whatever it takes’, two phrases that have had many mentions in the past week. There has been more ‘whatever it takes’ this week from the US Federal Reserve in providing support to markets, liquidity and companies but that was the title of last week’s blog update. This week, we have also seen great shows of unity, none more so than the applause for the NHS last Thursday evening.
One of the major support mechanisms of central bank actions has been the extent to which they will support bond markets beyond government bonds. The US Federal Reserve has said they will buy corporate bonds which leads us to comment on the debt markets as we see them especially in the US.
Generally, investment grade and high yield (junk) bonds have endured a tough time suffering from poor liquidity especially in high yield with conditions not dissimilar to those described in last week’s blog’s section on ‘price-makers and price-takers’.
Demand and Supply
The markets that have seen the most significant price movements have been those where supply and demand have dominated any attempt at valuation. Last week we mentioned the investment trust market as a sufferer of that phenomenon, but it did allow us to top up positions at distressed prices before they rose as the demand/supply dynamic reversed – more demand than supply. The same cannot be said of the oil market where demand has plummeted, and supply remains abundant as the Saudis and Russians compete for market share and in the process, crush US shale producers. Many US oil and oil-related businesses have outstanding high-yield debt and defaults will surely follow.
Despite the US cavalry (Federal Reserve) coming to the aid of the US investment grade market and helping to reverse the significant yield increases/price falls in both investment grade and high yield, it pays to be selective in credit.
Many US companies previously raised debt to buy back their own stock and leverage their balance sheets, taking their credit rating to the lowest investment grade – BBB. Consequently, BBB rated debt mushroomed to historically high levels. In this economic climate there will be a number of ‘fallen angels’ – investment grade companies that are downgraded to junk. So far USD100 billion of debt has gone this way including Ford, the biggest so far. This will provide more opportunity in the higher echelons of junk/high yield – BB and B.
So basically, if you believe there is an opportunity in credit, you’ll need a credit specialist that can invest selectively across the spectrum in the higher quality elements of investment grade, supported by the Federal Reserve and the higher quality parts of high yield where credit selection is of paramount importance. There are few providers that offer that breadth of expertise that are not asset gatherers – we believe we own some of those few.
It was reassuring to see risk markets bounce from oversold levels, but volatility hasn’t gone away and oscillations will continue to be a factor of infection case trajectories in Europe and Government responses. As we noted previously, we had the opportunity to add selectively to investment trusts with solid business cases, at distressed prices as they began their price recoveries. Otherwise, we continued to transition into the digital economy from themes less persuasive for the next phase of economic development in a world that will have learned much from enforced isolation.
As we noted at the outset of this note, we’re all in this together. As a family firm, the founding family and staff sit alongside our investors in holding our two funds. We are well-equipped and enjoying the different environment of working from home which also means we are available should you wish to contact us.