By John Lloyd
In this video, Co-Head of Global Credit Research and Portfolio Manager John Lloyd discusses where investors can source income while trying to manage risk in a rising rate environment. He highlights where they see possible opportunities that may offer income while mitigating risk.
Shorter-duration and floating rate securities such as bank loans and CLOs may fulfill the need for income and may lower credit risk as rates rise.
The ability to allocate across sectors in order to source opportunities and avoid risk is critical for investors, particularly given where we are in the credit cycle.
John Lloyd: One of the areas we like in the market is short-duration securities, and there are a couple reasons for that. One, everyone is very worried. We're in a rising rate environment and as rates rise, generally, that will pressure your total return if you own a bond. Secondly, people are worried we're later in the credit cycle, so if you have a long-duration bond, it's going to be much more susceptible to where are spreads in the volatility on spreads if we go on a downturn, a recession, or any type of risk-off market. Even if you go into some type of downturn, the company is going to be able to pay off those bonds and you're really taking less credit risk to own that type of security.
I think I'm very positive on the U.S. consumer right now. We had tax breaks go through for corporates, which can lead to better employment trends. Although the wage growth hasn't been great, you are seeing wage growth and you're seeing economic growth that's generally pretty robust for the consumer in the United States. You have to be a select investor in the retail space given what's going brick-and-mortar retail right now. So some of the other areas are in the ABS sector and those can be auto lending, student loan lending, where it's really focused on consumer lending.
Floating rate securities, I think, are a place investors can go if they're worried about interest rates continuing to rise. So, it has a positive technical background for a couple of reasons. One, the Fed is in a raising cycle, so people expect there to be more raises over this year and next year from the Fed, and anything that's floating rate is based on LIBOR, and as the Fed raises, LIBOR and the interest you will receive will continue to increase over time.
I think there's a couple different areas of the floating rate market that investors can go to in search of income. One is the bank loan market. ABS has a couple areas within there as well. CLO market, so CLO liabilities, which are attached to the bank loan market as well, are interesting areas where investors can go search for yield.
I think the ability for investors to allocate across sectors is important when searching for income. I think there's a couple reasons why that's important. One, you can take a view on where you are on the cycle, and if you want to get defensive or if you want to be more opportunistic in your investing approach. So if you want to get more defensive, you can go up in capital structure and go into the bank loan market. You can go into the CLO market and go up in capital structure where you're still targeting yields, but you're being more defensive. I think as you get more positive on different sectors or different themes in the market or the market overall, that allows you to move into more opportunistic sectors. An example of that can be high yield or a down-in-capital structure in CMBS or ABS, where you're taking on a little bit more credit spread risk.
Disclaimer: Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.
High-yield or "junk" bonds involve a greater risk of default and price volatility and can experience sudden and sharp price swings.
Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. The principal on mortgage- or asset-backed securities may normally be prepaid at any time, which will reduce the yield and market value of these securities. Investing in derivatives entails specific risks relating to liquidity, leverage and credit and may reduce returns and/or increase volatility.
Bank loans often involve borrowers with low credit ratings whose financial conditions are troubled or uncertain, including companies that are highly leveraged or in bankruptcy proceedings.
Any risk management process discussed includes an effort to monitor and manage risk which should not be confused with and does not imply low risk or the ability to control certain risk factors.
LIBOR (London Interbank Offered Rate) is a short-term interest rate that banks offer one another and generally represents current cash rates.
(CLO) market is the US Collateralized Loan Obligation. Janus Henderson is a trademark of Janus Henderson Group plc or one of its subsidiary entities. © Janus Henderson Group plc.
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