Five reasons why 2023 could be a good year for global credit

The uptrend in bond yields globally in 2022 has pushed the prospective yield of credit portfolios close to the highest level in more than a decade. 

First Sentier Wholesale Global Credit Income Fund – yield

Source: First Sentier Investors. Data shown March 2014 December 2022

Yields on other income-producing investment options are rising too. One-year term deposit rates went from around 0.25% a year ago to more than 3% today, and yields on government bonds rose in 2022 too. But neither currently come close to the prospective yields available from global credit.  

We expect global credit yields to remain elevated throughout this year, which could prove enticing for income-oriented investors in particular.  

Large companies worldwide are in the process of releasing their financial results for the December quarter and for the 2022 calendar year as a whole. Early indications suggest most firms remain in healthy shape financially.  

While it’s possible the default levels might rise back up towards long-term average levels from an extremely low base, we’re not anticipating a meaningful pickup in default rates among corporate issuers.  

Encouragingly, the volume of corporate bonds with ‘negative’ outlooks from major rating agencies is close to the lowest level on record¹.

More importantly, higher default rates across the broader market will only affect portfolios if one of the companies in the portfolio defaults, either by missing a regular coupon payment or being unable to repay its debt on the maturity date.  

It’s very important to avoid the failures, so we’re always on the lookout for signs of distress and aim to sell bonds before escalating default risk starts to affect their valuation. 

The latest forecasts from the International Monetary Fund² suggest major economies will be quite resilient this year, despite headwinds from higher interest rates, ongoing supply-chain bottlenecks, and secondary impacts of the war in Ukraine. Any recessions are expected to be short and shallow in nature.  

We expect to see lower levels of economic activity in some areas, but is encouraging that the International Monetary Fund still projects global economic growth to be 2.9% in 2023; only down modestly from an estimated 3.4% last year.  

Credit investors should be reassured by these latest projections, as there’s generally quite a strong correlation between economic activity levels and company profitability. As long as companies can service their debt repayment obligations, the regular income stream from coupons will support returns from global credit portfolios. 

Institutional investors seem to be sitting up and taking notice of the higher prospective returns on offer.  

We have seen an uptick in due diligence with prospective investors considering increasing exposure to the asset class. Sophisticated investors in the US, Europe and elsewhere, including pension funds and sovereign wealth funds, are among the prospective investors looking to allocate to corporate credit portfolios. This is important, as sizeable inflows into the asset class typically help support valuations.  

During January, we saw a good level of new corporate bond issuance. More than US$160 billion of new corporate bonds were issued in the US alone during the month³, which ranks among the highest January totals on record.  

Encouragingly, all of this new issuance was comfortably digested by the market. This underlines the demand for credit worldwide and signals that there may still be large amounts of money sitting on the side lines ready to be deployed in high quality, yielding investments. This could help ensure new issues remain well-supported, and also potentially boost the valuations of existing securities trading in secondary markets.  

Operating conditions always vary for different firms, both geographically and across industry sectors.  

While the overall outlook for credit remains encouraging, there will almost certainly be pockets of weakness to avoid. This underlines the value of active management in this asset class. 

Over the past two years or so we’ve seen problems with Chinese property developers, for example, many of which had borrowed too much money and weren’t able to repay their debt following a slowdown in demand and an associated drop in revenue.  

On the flipside, we generally favour firms with pricing power in their respective industries, as they are less prone to margin erosion and are therefore least at risk of running into financial difficulty. 

Avoiding the blow-ups helps preserve capital and can result in our funds outperforming credit benchmarks and peers that might have some exposure to the defaulting firms.