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Attractive opportunities remain across 4 key credit markets

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This is a sponsored article from Capital Group.

It has been a challenging year for fixed income markets in 2022 amid rising inflation and slowing global growth. While uncertainty is likely to remain elevated, today’s starting yields offer an attractive entry point for long-term investors, according to Capital Group Portfolio Manager Damien McCann.

The broad credit universe provides ample potential to add value and target durable income streams through bottom-up research and security selection across four primary credit sectors — high yield, investment grade, emerging market (EM) and securitised debt.

  1. High yield is finally high yielding

The US high yield market is looking attractive again and could present a compelling opportunity to add to positions, should fundamentals continue to outperform expectations of slowing economic growth. With issuer fundamentals in good shape, the asset class is healthier and more stable than it has been in many years.

The high yield sector is instrumental to a multi-sector credit strategy, because over time it typically generates the highest level of income, which is the key contributor to total return over a full market cycle. The size and diversity of the sector allows for ample opportunity to add value through fundamental research and appropriate risk allocation across quality and industry.

  1. Investment grade corporates: higher quality but more sensitive to rates

Along with other fixed income asset classes, investment grade corporate bonds have repriced significantly this year, returning -18.7% year-to-date.1 Once again, however, valuations have improved and a yield of 5.7%2 has contributed to the portfolio manager’s recent decision to increase the sector’s weight.

Nevertheless, caution is warranted as the risk of recession, or at least a material slowdown in growth, is rising. Spreads could widen further, though not as wide as lower quality corporate debt. That said, with spreads having widened from recent tights, the risk of further spread widening is lower than in previous periods of declining economic growth.

  1. Emerging markets debt offers diversified sources of income and return

Persistent inflation, slowing global growth, tightening US monetary policy, a soaring US dollar and geopolitical tensions, including the Russia-Ukraine conflict and China-Taiwan tensions, are all currently weighing on emerging market debt. That said, cheap valuations in pockets of higher yielding sovereign and corporate sectors make us constructive on the sector.

Overall, the combination of relatively weak global growth and high inflation remains a challenging backdrop for EM debt hard currency, especially with a front-loaded Federal Reserve hiking cycle, highlighting the need to be selective.

  1. Securitised credit: a differentiated view of the US consumer provides potential

We believe a key benefit of including securitised credit in a diversified fixed income portfolio is its lower correlation with corporate credit.

Many of the fundamental drivers of this sector are distinct from corporate and sovereign credit. The result is the potential to generate similar returns while achieving healthy diversification. The securitised sector is smaller and less liquid than investment grade corporates and has a narrower quality spectrum. It is a short duration sector that has shown evidence of good credit quality and has the potential to offer attractive yield and defensiveness over time. The sector is also under-researched by many market participants, creating opportunities for our team of securitised credit analysts to identify mispriced investments.

The bottom line

All four sectors of the credit universe play an important role in providing consistent and durable income stream potential in bond portfolios.

The high income of the high-yield and emerging markets debt sectors can be balanced by the defensiveness of the higher-quality investment grade corporates and securitised sectors. The shorter duration of high-yield and securitised credit also tempers the higher interest rate sensitivity of investment grade and EM debt. Overall, credit spread correlations are reduced by the inclusion of securitised and sovereign credit. These sectors offer fundamental drivers that can be distinct from the corporate credit drivers in high-yield and investment grade corporates.

Given the uncertain economic environment, we believe taking a diversified, balanced approach to credit is more important than ever.

Click here to read the full 8-page analysis.

With US$458 billion in fixed income assets under management, Capital Group is the fourth largest active fixed income fund manager in the world3 – a distinctive approach to fixed income is the driving force behind this success.

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1 As at 30 September 2022. Data in US dollar terms, for the Bloomberg US Corporate Index. Sources: Bloomberg, Barclays
2 As at 30 September 2022. Index used is the Bloomberg US Corporate Index. Source: Bloomberg
3 All data as of 30 June 2022 and attributable to Capital Group, unless otherwise stated. Assets under management by Capital Fixed Income Investors. Source: Morningstar

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