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Multi‑Sector Credit: Flexibility Amid Shifting Markets

We believe an active, flexible, multi-sector approach may offer investors better long-term results by focusing on structural opportunities to generate alpha.

Global credit markets have transformed in the decade since the financial crisis, experiencing dramatic growth and periodic volatility. Dynamic markets continue to mean that traditional metrics such as ratings and sector type may be less informative, complicating the investment process particularly for investors who focus on timing their beta exposures to specific areas of credit (investment grade, high yield, emerging market debt, securitized credit, etc.). These kinds of directional bets on individual credit sectors may become even riskier as we enter the later stages of the credit cycle. 

How can investors navigate these late-cycle credit markets? We believe an active, flexible, multi-sector approach may offer investors better long-term results by focusing on structural opportunities to generate alpha.

Three credit market challenges

A flexible approach to credit market investing has become especially important due to three major factors:

  1. Size: The global credit markets reached over $20 trillion at the end of 2018, up from around $13 trillion a decade ago (sources: Bank of America Merrill Lynch, J.P. Morgan, Bloomberg Barclays, PIMCO). Along with growth in traditional segments, other areas like bank capital and structured credit have become more commonplace in credit portfolios.
  2. A growing market means more opportunities and more diverse risks that allow a multi-sector approach to best navigate the technical pressure from downgrades and potential defaults. The challenge of moving from corporate credit out into a wider credit universe is assessing the correlations of various products and sectors. Evaluating a bigger opportunity set requires large global resources, robust frameworks and advanced analytics distinct from traditional credit research.

  1. Changing credit risk: Many borrowers have taken advantage of an easy lending environment over the last few years to access relatively cheap financing, which may lead to distorted incentives:
    • Companies with a desire to stay investment grade (IG) have been able to raise more BBB rated debt (the lowest credit rating still considered IG) – the BBB market now represents 47% of the market versus 32% in 2008 (source: Bloomberg Barclays). The goal for many of these issuers is to manage their debt level and limit their weighted average cost of capital while pursuing mergers and acquisitions and share buybacks, etc.
    • The leveraged loan (bank loan) market has expanded from around $350 billion in 2008 to $1.1 trillion today, while generally shifting lower in quality – B rated securities represent 53% of the bank loan market today versus 25% in 2008 (source: J.P. Morgan). As a result, many companies have gravitated to the bank loan market, leading to issuance with less investor-friendly terms coupled with less subordination. 
    • The non-agency mortgage-backed securities (MBS) market remains structurally attractive, in our view, though about 95% of the market is rated below IG despite robust underlying fundamentals (source: J.P. Morgan).

    With these changes, it can be a challenge for investors to draw upon historical performance, correlations and comparisons to identify opportunities. Hence, it is ever more important for investors to perform underlying credit-sensitivity analysis to identify attractive valuations and opportunities. This analysis calls for deep resources that seek to understand cash flow and convexity profiles.

  1. Difficulty in timing beta: Trying to “time” a single sector beta can prove challenging, especially later in the credit cycle. If we encounter a more challenging macro environment, there is increased potential of fallen angels (i.e., downgrades from IG to high yield) and more pressure on liquidity, which may add to volatility and can make it difficult for investors trying to time the beta.
  2. Having flexibility to look across the capital structure is crucial in environments where tactical opportunities may be short-lived. This reduces the potential of being a forced seller, allows a more tailored portfolio of best ideas, and may help investors capitalize on tactical opportunities during market dislocations.

Flexible credit portfolios help withstand uncertain environments

Given late-cycle dynamics and the evolution of credit markets over the last decade, credit investors should ask, “Do I have enough flexibility in my portfolio to achieve my goals?”

For many investors, a multi-sector or broad approach to credit may best position them to benefit from these dynamics. A multi-sector approach aims to assess correlations and optimize risk factors holistically, as opposed to taking a different approach for each sector, and seeks to capitalize on structural credit market inefficiencies as well as shift in and out of credit betas tactically as valuations change. We at PIMCO believe managing credit is a human-capital-intensive area, necessitating a global credit research effort, advanced technological tools and strong analytics capabilities.

For detailed insights into our views on credit, fixed income and other asset classes, please read our latest Asset Allocation Outlook.

READ HERE

The Author

Sonali Pier

Portfolio Manager, Multi-Sector Credit

Eve Tournier

Head of European Credit Portfolio Management

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Disclosures

London
PIMCO Europe Ltd
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London W1U 3AH, England
+44 (0) 20 3640 1000

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PIMCO Europe GmbH Irish Branch,
PIMCO Global Advisors (Ireland)
Limited
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PIMCO Europe GmbH - Italy
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+39 02 9475 5400

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8002 Zurich, Switzerland
Tel: + 41 44 512 49 10

PIMCO Europe Ltd (Company No. 2604517) is authorised and regulated by the Financial Conduct Authority (12 Endeavour Square, London E20 1JN) in the UK. The services provided by PIMCO Europe Ltd are not available to retail investors, who should not rely on this communication but contact their financial adviser. PIMCO Europe GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany), PIMCO Europe GmbH Italian Branch (Company No. 10005170963), PIMCO Europe GmbH Irish Branch (Company No. 909462), PIMCO Europe GmbH UK Branch (Company No. BR022803) and PIMCO Europe GmbH Spanish Branch (N.I.F. W2765338E) are authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 32 of the German Banking Act (KWG). The Italian Branch, Irish Branch, UK Branch and Spanish Branch are additionally supervised by: (1) Italian Branch: the Commissione Nazionale per le Società e la Borsa (CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act; (2) Irish Branch: the Central Bank of Ireland in accordance with Regulation 43 of the European Union (Markets in Financial Instruments) Regulations 2017, as amended; (3) UK Branch: the Financial Conduct Authority; and (4) Spanish Branch: the Comisión Nacional del Mercado de Valores (CNMV) in accordance with obligations stipulated in articles 168 and 203 to 224, as well as obligations contained in Tile V, Section I of the Law on the Securities Market (LSM) and in articles 111, 114 and 117 of Royal Decree 217/2008, respectively. The services provided by PIMCO Europe GmbH are available only to professional clients as defined in Section 67 para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication.| PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-020.4.038.582-2) . The services provided by PIMCO (Schweiz) GmbH are not available to retail investors, who should not rely on this communication but contact their financial adviser.

All investments contain risk and may lose value.

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 the current low interest rate environment increases this risk. Current 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.

There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision.

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