“We see opportunities as reopening sectors still trade cheaply to less cyclical sub-sectors. We continue to favor rescue financings from 2020 as early tender candidates, as well as select energy overweights and consumer cyclicals, given the strength of the U.S. consumer. As always, use of diversified strategies, including bank loans, collateralized loan obligation (CLO) tranches and convertible bonds, where applicable.
“In our opinion, the best hedge to a high yield portfolio is prudent issue selection. Successful portfolio management will not be just about owning credits with upgrade potential, positive merger and acquisition (M&A) likelihood, or initial public offering (IPO) expectations leading to deleveraging. It will be about avoiding tougher stories, like leveraged buyouts (LBOs), re-leveraging balance sheets, deteriorating fundamentals and defaults.
“In our 50-year history, ESG has always been, and will continue to be, a key component of our bottom-up approach. The increased focus on ESG from investors and issuers will result in more green bond and sustainability bond primary offerings, which is healthy for the market and the planet.”
Commenting on rising interest rates, record CLO issuance, LBOs and M&A, Ryan Kohan, Head of Bank Loans, said:
“A rising interest rate environment is typically a very supportive demand environment for floating rate loans. We expect to see a greater appetite for floating-rate investment grade paper, which will maintain the strong appetite for CLO liabilities and drive continued CLO issuance. Loan mutual funds will continue to see inflows from investors looking for limited duration, attractively yielding products.
“Underlying loan fundamentals are currently very strong with healthy cash flow coverage, so we see ample cushion for borrowing costs to potentially rise. For example, current cash flow of the market is 3.6 times relative to the rate of below 2.0 times that we saw during the global financial crisis.
“Record CLO issuance this year has been driven by both investors’ demand for floating-rate investment grade paper as well as the attractiveness of new issue CLO equity returns. Those equity returns remain attractive due to bank loan spreads remaining wider than pre-COVID levels, despite the tightening of liabilities. We have experienced very balanced supply and demand conditions as significant new-loan issuance has occurred this year.
“Regarding the increase of LBO and M&A activity in 2021 versus 2020, we see an opportunity for active, disciplined managers to differentiate and drive returns through credit selection in the single B rating category. Generally, we see this as creating a great deal of investment opportunity, though our primary concerns are around certain cyclical sectors leveraging the post-COVID boom or dividend recapitalizations. In addition, we will be closely monitoring credit sectors with significant leverage profiles that also have substantial exposure to labor, food or commodities and thin margin profiles.
“Looking at opportunities in the future, in addition to opportunities in single-B first lien loans, we see certain second-lien opportunities in the strongest businesses presenting higher carry through subordination, rather than reaching for risk in the market where distressed trades in a price context of 90.00%. Finally, we see a select remaining COVID-impacted names as opportunities with long liquidity profiles, a clear path to recovery and modest leverage profiles.”
