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Text on screen: Daniel J. Ivascyn, Group Chief Investment Officer
Ivascyn: One of the most common questions we've been getting recently is regarding corporate credit more broadly, questions around the relative valuations of public and private credit.
Anytime you have a significant shift in investor thinking regarding economic risks or credit risks, we've really seen once again, the public markets lead the overall credit markets lower. So when you look today at opportunities in the public market versus appropriate private market comps, you're seeing significantly greater yields for similar risk within the public market,
FULL PAGE GRAPHIC: TITLE - As the distinction between public and private credit markets has blurred, many segments are trading at similar levels. Subtitle: Yield to worst across various income sectors. This graphic is a bar chart comparing yields across fifteen different classes of credit products, in three different product categories. The categories are: “High carry sectors not represented in AS Agg.,” “General private markets (unlevered),” and “Private markets (levered).” Yields are roughly the same in the high carry and general private markets categories, with a shared median range of around 7%, while they are higher in the private markets category, which holds a median range of around 10%. This relates to the previous graph, in that both public and private yields are around the 7-8% yield range, on average.
and what that typically means is that over the course of the next few quarters, as some of the lagging marks in the private segment of the opportunity set adjust, you could see convergence in that direction or you'll see public markets regain a bid and tighten back towards the private counterparts that look quite similar in terms of overall risk. But this is an environment today where, due to market segmentation, many strategies targeting private credit opportunities in a very narrow sense, you continue to see these markets operate at very, very different levels for relative value perspective.
Again, it's fairly extreme today during other periods in history, but also consistent with how markets tend to perform when you have again, a big shift in overall market sentiment.
And then in terms of the philosophy for investors within these markets, we see opportunity today within the public space, both in the form of higher yields, in the ability to drive terms, better covenants.
FULL PAGE GRAPHIC: TITLE - Starting yields across asset classes look more attractive after the recent repricing of the yield curve. Subtitle: Today yields are at a much stronger starting point. This graphic is a bar chart comparing yields across seven different classes of bonds. The comparison is of yields on December 31st, 2021, with yields on July 18th of 2022. Each bond class shows a substantial gain in yield, with more than half of the classes of bond more than doubling in yield. The three bond classes with the most substantial rise in yield, are HY Credit (7.7% yield, with a 388 basis point gain), HY Munis (8.4% yield, with a 380 basis point gain), and Munis (5% yield, with a 318 basis point gain), respectively.
So we think that investors should begin to be much more active within that public opportunity set, even consider shifting some assets from private oriented strategies into this area that has lagged and lagged quite significantly. But also, investors should be preparing for what we think is a multi-year opportunity to take advantage of dislocation within the corporate credit opportunity set more broadly.
FULL PAGE GRAPHIC: TITLE - Anatomy of a cycle: Fed moves, public markets react first, creating domino effect across the liquidity spectrum. The graphic is a line graph depicting movements in the federal funds rate over a six-year economic cycle, from December 2016 to December 2022, accompanied by three text boxes describing each two year cycle, and PIMCO’s recommended investment strategy for each stage. The first two-year segment, from 2016-2018, is accompanied by rising rates and a text box that summarizes: Rising interest rates, higher financing costs and uncertainty regarding growth / monetary policy. Be patient and focus on resiliency. The second two-year segment, from 2019-2021, shows rates peaking and then dropping precipitously. It is accompanies by the second text box, which states “Economy slows: Rates peak, monetary policy becomes less hawkish and tailwinds for senior credit improve Target rich backdrop for high quality credit.” In the third segment of the graph, beginning at the end of 2021, rates are shown to rise, and then projected to rise further. The segment is accompanied by the third text box, which reads: “Private market impact: Higher borrowing costs and fundamental challenges reach private markets. Target rich environment for opportunistic / special situation strategies.” In summary: When rates rise and monetary policy is uncertain, be patient and focus on resiliency, when the economy slows, high-quality credit opportunities abound, and now that borrowing costs are rising again, with new fundamental challenges, one should focus on opportunistic and special situation strategies.
We don’t need a crisis for there to be opportunity. It's simply the response to significantly weakening economic growth and the prospect for even a slight to moderate recession. So we think, again, react quickly to this significant jolt in valuation in the public space, be much more patient and careful allocating to private opportunities today, especially at significant yield gives versus the public markets, but also prepare and begin to focus more on what we think is going to be a significant opportunity within both public and private credit, with private opportunities, inevitably lagging opportunities within the public space, as they typically do during similar economic environments.
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Disclosure
Past performance is not a guarantee or a reliable indicator of future results.
Forecasts, estimates and certain information contained herein are based upon proprietary research and should not be interpreted as investment advice, as an offer or solicitation, nor as the purchase or sale of any financial instrument. Forecasts and estimates have certain inherent limitations, and unlike an actual performance record, do not reflect actual trading, liquidity constraints, fees, and/or other costs. In addition, references to future results should not be construed as an estimate or promise of results that a client portfolio may achieve.
There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest for a long-term especially during periods of downturn in the market. No representation is being made that any account, product, or strategy will or is likely to achieve profits, losses, or results similar to those shown. Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest for the long-term, especially during periods of drawdown in the market. Outlook and strategies are subject to change without notice.
Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Income from municipal bonds is exempt from U.S. federal income tax and may be subject to state and local taxes and at times the alternative minimum tax. Mortgage- and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and while generally supported by a government, government-agency or private guarantor, there is no assurance that the guarantor will meet its obligations. References to Agency and non-agency mortgage-backed securities refer to mortgages issued in the United States. High yield, lower-rated securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Bank loans are often less liquid than other types of debt instruments and general market and financial conditions may affect the prepayment of bank loans, as such the prepayments cannot be predicted with accuracy. There is no assurance that the liquidation of any collateral from a secured bank loan would satisfy the borrower’s obligation, or that such collateral could be liquidated. General risks about private strategies: The strategies involve a high degree of risk and prospective investors are advised that these strategies are suitable only for persons of adequate financial means who have no need for liquidity with respect to their investment and who can bear the economic risk, including the possible complete loss, of their investment. All investments contain risk and may lose value.
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