It’s a smart time to start buying junkier junk debt, according to Ashish Shah, Co-Chief Investment Officer of Fixed Income at Goldman Sachs Asset Management.
A flight to quality into higher rated debt has pushed the average price of riskier single B leveraged loans down to 95.46, the lowest since early January, according to the Credit Suisse Liquid Leveraged Loan index. Double B rated loans, though, have dipped only slightly over the past few weeks to 99.2.
That’s helped create pockets of value for investors in some debt that has sold off, but they may still need to brave potential volatility, Shah said in an interview. The dispersion is especially prevalent in the leveraged loan market, which has come under strain following billions of dollars of outflows and constraints on how much B3 rated debt collateralized loan obligations can buy, he said.
“We are starting to find opportunities where we are willing to go down in quality,” said Shah. “We think the market is being too bearish on the economy and we are finding good value in “mid quality” high yield.” GSAM has US$1.56 trillion in assets under management.
Investors are seeking safety from sectors and companies perceived more at risk from a slowing economy.
But Shah reckons potential losses over the next 12 months are limited. Manufacturing is vulnerable to a slowdown, but the broad-based economy is fine and support from central bank easing hasn’t filtered through yet and should help offset weaker growth in Europe and Asia, he added.
“Things have to get a lot worse to lose money,” said Shah.
GSAM has also been buying debt of lower rated investment-grade companies that are deleveraging, have good free cash flow and are not overly cyclical. Some names that have fallen into the BBB band, which sits just above junk, have attractive valuations as well.
Among securitized products, CLO liabilities look appealing, while agency mortgages are also attractive as the Federal Reserve has shrunk its balance sheet.
Investors may have to brace for some ups and downs before year-end amid uncertainty over Brexit and ongoing trade negotiations between the U.S. and China. Yet that could be another opportunity if Shah’s expectations are right that a broad-based hunt for yield will not resume until 2020. That’s partly because investors may want to lock in strong returns they’ve already made this year, he said.
High-yield bonds have returned more than 11 per cent this year, the most since 2016 on a year-to-date basis. Leveraged loans have returned less, but they’re still a robust 6.14 per cent.
“There’s a lot less risk tolerance,” said Shah. “In the new year, people will start to go to where there is opportunity.”