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Should we fear a major credit accident?

There is a split in opinion on credit exposure as bond markets grapple with the normalisation of monetary policy.

Should we fear a major credit accident?

In the first week of February a number of firms came forward to say they were reducing credit exposure due to concerns over a liquidity squeeze. 

This was prompted by worries over future interest rate rises, while the general complacency after markets recovered some of their losses in January, was another cause for unease. 

Seven Investment Management, Brooks MacDonald and Ruffer were among those warning of a growing bond risk. 

However, feelings across the industry are far from uniform.

Despite a certain sense of caution, there is no apparent alarm among wealth and asset managers, with some adopting a more wait-and-see approach while others dismissing such fears altogether.

Watchful but not panicking

Thomas Wacker, head of credit at UBS’s wealth division, said the increasing risks are not high enough to take immediate underweight positions, although he finds the current environment to be one where outperforming means avoiding the blow ups.

This is likely why last year the firm advised its clients not to take any extra credit exposure.

The strategic position of a UBS global balanced diversified portfolio has a 5% allocation to high yield credit and 6% to emerging market bonds at the higher end of the risk spectrum.

‘The big points for us are concerns over illiquidity,’ Wacker said. ‘There is much talk about a recession next year, and credit is an asset class that falls earlier than equities, so we are cautious. It’s not only about more defaults, but selling pressure facing illiquidity that could trigger spread spikes.’



Being underweight the asset class relative to its strategic asset allocations since the beginning of 2018, Brewin Dolphin is taking a calmer approach.

Fund research analyst Shakhista Mukhamedova (pictured above) said the decision was driven by both valuations and fundamentals.

Rising inflation expectations, central banks unexpectedly turning hawkish or market perception that they are behind the curve would send bond prices tumbling, she explained.

‘From the credit risk perspective, a deterioration in capital markets conditions could tip bonds’ total returns into negative territory.’

She believes it’s unlikely there will be a similar trigger to what happened during the global financial crisis.

‘The shock this time could come from the companies being unable to pass on wage growth costs to the consumer and having to absorb the higher labour costs depressing their bottom line. The leverage then would become harder to maintain.’

A multi-asset point of view

Views among multi-asset managers are also divided. Citywire + rated Daniel Lockyer, who manages the Hawksmoor Vanbrugh, Hawksmoor Distribution and Hawksmoor Global Opportunities funds, said he has held a guarded stance for several years.

But others, such as Citywire A-rated Jeroen Blokland (pictured below) of the Robeco multi-asset One and Pension Return Portfolio funds, are more relaxed.



Blokland’s portfolios now have some 30% in credit and 45% in equities, but zero government bond positions.

Although it can be hard to predict the odd business going under, he said he spots no discernible default trend in Europe or the US. He has shifted his government bond exposure to credit and some eurozone positions to the US.

Lockyer (pictured below), on the other hand, refuses to view the ‘extraordinary environment’ of the past decade as normal. And he believes the increased use of exchange-traded funds (ETFs) and other passive solutions in bond markets is a concern that could send bond prices tumbling.



To avoid ensuing threats, he safeguards his portfolios by investing in the asset class through certain investment trusts that are accessing parts of the bond market that traditional open-ended funds cannot.  

‘These include secured or asset-backed loans such as those linked to infrastructure projects or property assets.

'Most of the funds’ bond exposure has little duration to mitigate against the risk of rising interest rates, and we have broadened our exposure into global areas such as emerging market debt or US Treasury inflation-protected securities,’ he said.

Currently, Hawksmoor Vanbrugh, which usually has at least 30% cash and bond exposure, now stands at 34.2%, of which 7% is cash. The Distribution and Global Opportunities funds, with no constraints in the asset class, have 32.7% (5.5% cash) and 10.7%, (2.5% cash), respectively.

Elsewhere, Michel Perera, chief investment officer at Canaccord Genuity, dismissed the calamity concerns and said that despite slower economic growth, he finds fears of a US recession in the next 24 months exaggerated.

Fixed income exposure in a Canaccord average balanced portfolio currently stands at 21%, the lowest level in a while, but this is due to the firm’s dislike of government bonds, Perera said.

‘We don’t have government bonds now, because even if we go into a recession, we won’t get a good return on them,’ he said.

‘If we feared a credit accident, we would firstly sell equities, because the risk is much higher. Then we would sell corporate credit and we would reinvest it in government bonds.

‘We would go a lot into cash and sell credit, but equities would go first.’  

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