Will credit remain immune from the rising rate environment?
Neuberger Berman, a US$405 billion ($527 billion*) global multi-asset manager, this week highlighted the opportunity arising in credit markets amid the bond and equity market selloff. Commenting on recent events that have seen the 10-year US Treasury bond begin 2021 at a yield of 1.0% and reach 1.6% in recent weeks, the firm’s chief investment officer – fixed income, Brad Tank. suggests that rate increases haven’t “disturbed the peace for fixed income and credit managers yet.”
In the widely read weekly missive, Tank addressed the elephant in the room, being a widely expected increase in inflation, noting it had been the subject of four of his last six weekly updates. Despite suggestions that higher bond rates may be negative for the affordability of the debt issued by borrowing companies, he highlighted that the early cycle economic recovery conditions continue to support the sector.
Tank noted that the concept of “duration in equities” was restricted to technical discussions until 2020, at which point it “became a thing.” He noted that loss-making growth stocks are” theoretically the most sensitive to rates because their earnings are expected to be weighted further into the future,” which saw them lead the 2020 market rebound. However, they began to underperform in December as value and cyclical stocks took off.
Interestingly for yield-starved investors, investment grade corporate bond issuers are ”more likely to be value companies than growth companies,” with high-yield issuers ”more likely to be cyclical,’ which is exactly those sectors that are benefiting most from the economic recovery. This is why within Neuberger Berman Strategic Income Fund, a multi-sector fixed income portfolio managed by Tank, the firm has been allocating to the high yield corporate bond market and to selective opportunities in investment grade corporate debt.
As highlighted in Giselle Roux’s article here, investments in the credit sector can continue to perform strongly by a further contraction in credit spreads, which according to Tank have enough room to offset – or even overturn – the effect of rising rates on bond values. “Since the start of the fourth quarter of 2020, the US 10-year yield has risen by more than 80 basis points, while the spread of the ICE Bank of America US Corporate BBB Index has tightened by more than 60 basis points, and that of the US High Yield Index by almost 200 basis points, for a total return of almost 7%” he says.
While there is some confidence in the expectation that inflation will arrive, Neuberger Berman remains sanguine on the long-term outlook for rates, expected to remain under the 2.0% cap for the US 10 year in 2021, with the firm’s expectation being 1.75%. Commenting on the market’s seeming obsession with bond rates, Tank noted, “we also think that the rising rates phenomenon might be close to burning itself out for now.”
The group has in recent weeks moved further from the parts of the market that are most sensitive to rising rates and into global high-yield credits that it believes have upgrade potential. Importantly, Neuberger Berman does not see a “sustained bear market in risk assets” in the immediate future.
Neuberger Berman manages the NB Global Corporate Income Trust (ASX:NBI) an $905 million** listed investment trust (LIT) on the Australian Securities Exchange (ASX). It has also expanded its product suite with the diversified fixed income product, the Neuberger Berman Strategic Income Fund becoming more widely available.
*Source: Neuberger Berman, data as of December 31, 2020
**Source: Neuberger Berman, data as of February 28, 2021