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March 2019 | GSAM Connect

Keep Calm and “Carry and Roll” On

In short: We remain overweight US corporate credit but have scaled back exposure in light of strong early-2019 performance, with US investment grade and high yield corporate credit spreads tightening 37bps and 142bps, respectively, from December or January wide levels1 . Heading into the second quarter we are focused on generating returns from ‘carry and roll’ opportunities rather than spread compression.

In detail:
 
  1. Spreads – less disconnected from fundamentals: We entered 2018 neutral to modestly overweight US corporate credit; macro and corporate fundamentals remained healthy but valuations were extended with US investment grade and high yield spreads commencing the year in their 13th and 14th percentiles, respectively2 (Exhibit 1). We retained this view until the final quarter when we believed corporate credit valuations dislocated from fundamentals. In our view, a likely moderation in macro and earnings growth in 2019 relative to 2018 did not warrant the sharp spread widening observed in late-2018. As such, we added overweight exposure at attractive levels. We remain overweight but in light of strong performance over the first quarter—spreads have migrated to their 37th percentile in investment grade and 28th in high yield—we have scaled back our exposures.

  2. Carry and roll – the focus going forward: Heading into the second quarter we have shifted focus from seeking to benefit from spread compression and capital appreciation toward ‘carry and roll’ opportunities. In turn, we have a slight preference for investment grade over high yield in multi-sector fixed income portfolios. Carry refers to the additional compensation (or “spread”) above the risk-free rate that corporate bonds offer; it is determined by perceived credit risk and maturity; investors require a premium to invest in riskier and longer-dated bonds. Careful security selection enables us to identify credits which offer attractive risk-adjusted spread. Investors can also generate return from “rolling down the curve” (or “roll down”) due to spreads tightening as bonds move closer to maturity. A steeper curve provides greater potential to generate return from roll down through the passage of time. For example, we currently have a preference for the intermediate portion of the BBB-rated curve due to its steepness relative to other portions of its own curve and relative to the A-rated curve.

Exhibit 1: Corporate credit spreads have tightened so far this year following late-2018 widening

Source: Bloomberg Barclays US Corporate, US High Yield, Euro High Yield and Euro Corporate indices. As of February 2019. Past performance does not guarantee future results, which may vary.

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