A more vulnerable credit market means that loan investors have to be particularly assiduous about doing their homework, said Frank Ossino, bank loan sector head at Newfleet Asset Management.
“Credit selection is going to be critical,” Ossino said. “As we enter a downward cycle, risk assets will be impacted and loans - as a credit risk asset class - will naturally be a participant.”
As leveraged loans are becoming less interesting to some investors, investment-grade bonds are poised to gain ground. More than half of respondents said they expected investment-grade credit to outperform next year, while about a fifth said they expected junk bonds to do better. Longer-term high-grade bonds generated returns of more than 9% in November, their best month since 2008.
Wall Street banks have also been talking lately about potentially high returns for investment-grade credit in 2023. Bank of America sees the debt generating total gains of close to 13% next year in the US, based on its index.
UBS said that credit can offer once-in-a-decade returns, recommending macro trades including going long blue-chip company debt compared with leveraged loans. But timing the trades is critical, strategists led by Mish said, as recession looms and won’t reach every economy at the same time.
Investor optimism about high-grade credit has been increasingly reflected in risk premiums. Spreads for US investment-grade debt have narrowed about 35 basis points since mid-October, according to Bloomberg index data.
Investment-grade credit is typically far more sensitive than junk bonds to changes in benchmark yields, because high-grade debt tends to take longer to mature and pays less interest. That makes investment-grade debt a better bet when yields are falling, as they have been in recent weeks.
Investment-grade bonds in dollars have returned 8.7% since Oct. 21, compared with 5.2% for high yield. High-grade debt is still on course for -- by far -- its worst year on record.
--With assistance from Airielle Lowe and Tomoko Yamazaki.
This article was provided by Bloomberg News.