Opportunities on the Horizon: Investing Through a Slowing Economy

Thematic updates | WEALTH OUTLOOK 2023 | MID-YEAR EDITION | 36 ABCs: Avoid bad credits Due to concerns over a possible recession and the lack of capital for more highly leveraged companies, we would not advocate for investing in lower-rated high yield bonds or loans unless investors are knowledgeable about the credit risk of these companies. Suitable investors who have patient capital to deploy may find that alternative fixed income managers with stable capital pools and expertise in security underwriting will prosper. By using sophisticated modeling and due diligence, they can seek to selectively provide liquidity in times of uncertainty and limited capital availability from capital markets and banks. Spotlight on private credit In marked contrast to the flood of money into T-bills and money market funds, the opposite has been true for leveraged loans and high yield bonds. Three consecutive and sizable major bank failures caused new loan issuance to plummet. Seventy percent of leveraged loans issuances in 2022 occurred in the first half of the year. In the third quarter of 2022, syndicated loans got hung up on bank balance sheets, leading sellers to deeply discount the loans they wanted to sell, with pricing in the low 90s relative to par in many cases. Now liquidity has dried up. In the first quarter of 2023, just $69.9B of leveraged loans were issued, the lowest quarterly amount since the fourth quarter of 2014 ( FIGURE 2 ) . When illiquidity equals potential opportunity for investors When credit tightens, borrowers pay higher yields and receive lower loan to value funding, providing bond and loan investors better protection and higher returns on performing credit. Yields on B-rated new issue loans climbed to 11.26% as of March 31, 2023 ( FIGURE 2 ) . We expect that yields for complex credits in public markets and for private lenders may rise even more. As banks have become more risk averse, there is potential opportunity for lead credit investors to provide private market strategies to companies, extending out maturities for benefits including higher coupons, fees, and/or improved collateral. This is why we suggest that investors with the suitable investment objectives and two- to five-year horizons consider an allocation to direct lending funds and business development companies (BDCs) that seek to generate higher total returns without taking excessive risk. FIGURE 2 : Leveraged Loan Volume Is Down but New Issue Yields are Up 0 2 4 6 8 10 12% 0 200 400 600 800 $1,000 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Q1 Leveraged Loan Volume B-Rated New Issue Yields Billions Yields Source: LCD as of March 31, 2023 Indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Index returns do not include any expenses, fees or sales charges, which would lower performance. Past performance is no guarantee of future results. Real results may vary.