Lukas Strobl: To put it lightly, we are in turbulent times when it comes to European credit. The last year was volatile enough, and now the region’s banks, who account for a big cohort of investment grade issuance, are facing a confidence crisis. That said, turbulent times are often times where it pays off to go with active management. I’m here today with analyst Shannon Kirwin, who covers bond strategies for Morningstar. Shannon– is this the time to invest in European credit at all?
Shannon Kirwin: Hi Lukas. As a manager research analyst I don’t really focus on making market timing calls. My job is more to identify strategies that we believe will outperform over the long term, and we encourage investors to stay in a strategy over a full market cycle. With that being said, for someone who’s looking at their portfolio right now, given the volatility that we’re seeing and the scary headlines that we’re seeing, right now, there’s a case to be made that investment grade credit is a lot more robust than many investors think at the moment.
First of all, spreads have come out dramatically in 2022 in the corporate sector and we haven’t really seen spreads come in significantly since then. There’s been some tightening, but spreads are still well above their historical levels. So from that perspective, there’s a little bit of an argument to be made that there’s some relative value to be seen within investment grade credit. On the other hand, you had referred to some of the headlines that we’ve been seeing, a lot of the market volatility that we’re experiencing and there it’s also important to remind ourselves that in investing, volatility is a normal part of the process. And in fact, volatility is where a lot of managers see the best opportunities to add value.
That’s not to say that there aren’t a lot of factors right now that will make investment grade credit not exactly smooth sailing over the next couple of months. There are a lot of areas of unpredictability for example, it’s unclear how inflation is going to develop. It’s unclear how much the ECB is going to have to raise rates to bring inflation down, which could spark a recession. We’re seeing the headlines with Credit Suisse and some uncertainties surrounding the financial sector after a couple of big bank collapses in the U.S. last week. But on the other hand, something that we hear again and again from European credit managers is that if you actually look at the universe of issuers in this sector, they’re a lot better positioned to weather a recessionary environment than this cohort of issuers was coming into most of the recent downturns that we’ve seen.
So on the one hand corporate balance sheets are looking a little bit better versus historicals and then European banks in fact are much better capitalized on average than they have been in the past as well. So, that actually provides a lot of evidence for the fact that there are opportunities to be grasped within the European corporate sector and in fact, you know, when we have these volatile markets, that’s actually the type of environment where we will see an active manager maybe having an opportunity to add value, because when markets come under stress and borrowing costs go up it’s the companies that have healthier balance sheets, that are better prepared that we start to see outperform and the weaker companies are going to be struggling to keep their credit ratings. So for a manager who’s actually put in the work to research issuers and to identify those companies that are going to be stronger, this might be the type of environment where we actually see those strategies outperform.
Strobl: Now, where are some of those best managers? Are there any strategies that you’d like to highlight in this environment?
Kirwin: Sure. So there are quite a number of strategies that we rate positively within this space. One that I would highlight is Robeco Euro Credit Bonds. This is an actively managed strategy. The investment management team here combines both top down management and a very big emphasis on bottom up company research. So on the one hand they have a very large stable of credit analysts– more than 20. So they really are familiar with the companies that they invest in. And then at the same time you have a large cohort of portfolio managers within this company who are very focused on managing the top down market beta that their funds have and being very active. So you might see this strategy be a little more exposed to derivatives or some index CDS products in order to manage those top down elements of the portfolio. But we think they do both elements really well. So this is a strategy that we rate. They have Morningstar analyst ratings ranging from silver for their cheapest share classes down to neutral for the most expensive ones.
There’s another strategy I would mention. It’s a slightly different style. Schroder ISF EURO Corporate Bond. That strategy is a little bit more aggressive. So while Robeco tends to maintain a more diversified portfolio, you’ll see Schroder taking a little bit more credit risk in this portfolio. But again, they have a very strong emphasis on bottom up research, so they really know their credits and over the long term, we’d expect both of these funds to outperform. So, Schroder as well sports a Morningstar analyst rating of silver for its cheapest share class. And these are two active strategies that we think could have an opportunity to shine.
Strobl: Alright, I should ask you– do either of these hold Credit Suisse bonds?
Kirwin: So they both do have some exposure based on the holdings data that we have. Credit Suisse is a very big issuer in the European investment grade corporate indexes. So this is something that we see across both active and passive portfolios, just because it’s such a big index component. The Robeco exposure that we saw was quite small, looked like just about 12 basis points or so in their most recent holdings from January. And then for Schroders looking back towards the end of last year, it looked like they had a manageable exposure of about 50 basis points. If you compare that to some of the passive products that track indexes in this space, we’re seeing exposures of around 70 to 80 basis points. So yeah, these are not massive exposures that you know would raise a huge red flag for us.
Strobl: Active management is going to be key when the going gets tough. Shannon, thank you for these picks and for explaining the situation. For Morningstar I’m Lukas Strobl.
