Bloomberg
Wall Street is protecting inflation from its debt market portfolios
(Bloomberg) – From money managers at BlackRock and T. Rowe Price, to analysts at Goldman Sachs, to credit stores run by Blackstone and KKR, a new economic reality is driving Wall Street’s most powerful forces to adjust its investment strategies. investment. The rise in inflation that will accompany the post-pandemic economic boom is threatening to reverse the four-decade decline in U.S. interest rates, triggering a race to protect the trillions of dollars worth of investments in the debt market. The first signs of this change have already emerged: these companies and others are transferring money for loans and notes that offer floating interest rates. Unlike fixed payments on most conventional bonds, those in floating rate debt rise as reference rates, helping to preserve their value. “We have had a long 35 to 40 year drop in rates, which has been a great support for fixed income investment rates, a great support behind the expansion of stock multiples, and for those of us who live and breathe investing, have been a wind on our backs for a long time, ”said Dwight Scott, global head of credit for Blackstone, which manages $ 145 billion of corporate debt. “I think we no longer have wind in our back, but we still don’t have wind in our faces. That’s what the inflation talk is about. ”To be clear, no one is predicting the kind of rampant inflation that has disturbed the United States’ economy for nearly five decades. However, a subtle tidal shift is already underway, many say. Not since 2013, in the months before Federal Reserve Chairman Ben Bernanke unleashed the so-called fury crisis by suggesting that the central bank could begin to slow the pace of monetary stimulus. global bonds are under so much pressure to start the year. Fueled by growing concern that price pressures may resurface amid an economic boom driven by vaccines, pent-up consumer demand and another round of government stimulus, 10-year Treasury yields skyrocketed by more than 0.4 percentage point. Amid the turmoil, perhaps no market is attracting more attention than leveraged loans. Weekly flows to funds that buy this debt have already exceeded $ 1 billion three times this year – sparking new foam talks – after not having exceeded that limit since 2017. The relatively high yields of the asset class make it an attractive investment for companies seeking juice returns as the gap between Treasury rates and corporate debt narrows. At the same time, policymakers’ continued monetary and fiscal support are expected to boost corporate profits by helping them cut debt multiples that have increased in the midst of the pandemic. However, what makes leveraged loans especially attractive to many is its fluctuating payment flow. As the long end of the Treasury curve continues its dramatic rise, its lack of duration – or price sensitivity to movements in underlying rates – provides significant protection to investors, even in an environment where the Fed keeps its interest rate close to zero and up front “You don’t buy leveraged loans today because you expect the floating rate component to rise,” said Lotfi Karoui, chief credit strategist at Goldman Sachs. “This is not the thesis. The floating rate component will remain stable in the near future. You buy because the theme of reflation is something that harms the high-yield bond market more than the loan market. ”This does not mean that junk bonds are not attracting their fair share of money either. The asset class can often be a safe haven from the threat of rising rates, given that an improving macroeconomic scenario tends to reduce credit risk, allowing spreads to contract. The new issue is at a record pace earlier in the year, and the relentless search for risky assets pushed debt yields below 4% for the first time earlier this month. Given the prospects for robust growth, Michael Kushma, director of global fixed income investments at Morgan Stanley Investment Management, said he is comfortable with further lowering credit quality for B and CCC rated securities to generate returns. The company has also added exposure to leveraged loans “when it makes sense,” he said, noting that some customers cannot keep debt in their portfolios. Still, some say record low yields, even in the riskiest segments of the speculative bond market, combined with the fact that average maturities have risen sharply in the past year, increased potential risk and diminished the appeal of the equity class. assets as a shelter from loans. “We increased our allocation for bank loans, in part by selling high yields,” said Sebastien Page, head of global multi-assets at T. Rowe Price, by email. “To put it this way: if we can get similar yield on high yield and loans, on a risk-adjusted basis, the asset class that should behave better at rising rates – loans – looks more attractive.” Floater FeverNot every asset manager can simply increase their credit risk, of course. For many, an alternative is the floating rate banknote market, a generally sleepy corner of high-grade credit with a very narrow buyer base. In recent weeks, demand has increased as investors seek to avoid negative total returns on fixed-rate debt. It is fueling an outbreak of new issues, including the first non-financial deal linked to the Secured Overnight Financing rate, the benchmark designed to replace Libor as the benchmark rate for hundreds of billions of dollars in floating rate debt. “The big risk in the market really is inflation, whether transitory or something more ingrained,” said Arvind Narayanan, head of investment-grade credit at Vanguard. “There is an enormous amount of stimulus in the market, both monetary and fiscal, that favors economic growth.” Others are turning to more esoteric asset classes, including secured loan obligations and private credit, as they seek higher yields and more fluctuating exposure rates. Blackstone has accelerated investments in leveraged loans and direct loans in recent years and accelerated the shift last month, according to Scott. He also became one of the largest CLO managers in the world. Western Asset Management has increased allocations for leveraged loans and CLOs and continues to believe that asset classes are an attractive opportunity, according to portfolio manager Ryan Kohan. Hiccups in the recovery can quickly shake inflation expectations and cause rates to shrink. Optimists also argue that the chances of price pressures that were not present before the pandemic suddenly appeared in its aftermath are minimal, at best, given the structural continuity “Inflation will be more transitory than sustained,” said Dominic Nolan, senior managing director of Pacific Asset Management. “We have to see how steep the curve is and whether the perceived inflationary pressures really materialize in inflation.” However, many say that the Fed’s apparent tolerance for overshoot ahead of inflation in the coming months and years makes this period different. it may well be a prelude to inflation, given the current macroeconomic environment, ”said John Reed, head of global trade at KKR, who manages around $ 79 billion in credit assets. “A modest increase in rates outside current levels seems likely for the remainder of 2021, but the Fed has been transparent in wanting the market to invest behind yield, growth and recovery.” (Updates with comment from Western Asset Management in the 24th paragraph). more articles like this, visit us at bloomberg.comSubscribe now to stay up to date with the most trusted business news source. © 2021 Bloomberg LP