In an environment reshaped by Covid-19, increased periods of dislocation present investment potential to corporate credit investors. We believe a locked-capital, draw-down approach offers the most compelling way of generating outsized returns.
Following a summer of lockdowns and coronavirus-led newsflow, the next 12-18 months will undoubtedly bring political and economic uncertainty to many corners of global markets, potentially triggering further economic and financial stress.
We believe this could be felt most severely amongst corporates, some of which could encounter financial difficulties ranging from covenant breaches to outright defaults.
The anticipation of a drastic economic slowdown and ensuing capital flows has created dislocations in pricing and capital availability across the credit spectrum – none more acute, in our view, than in emerging markets (EM).
Further market dislocation is likely to be on the horizon, particularly in the illiquid portion of the EM universe, where corporate newsflow or simply de-risking activities among banks can result in outsized price moves.
However, bond markets have shown us over the last few months that many of these pockets of volatility are only temporary, particularly when there is a mismatch with the credit fundamentals of the underlying asset.
Given the fundamental structural considerations, we believe a targeted, barbell approach, focusing on a combination of high-quality performing credit on one side, with stressed names trading at depressed levels below intrinsic recovery values on the other, is required to navigate current markets and capitalise on those investment opportunities that can generate outsized returns.
"Bond markets have shown us that many of these pockets of volatility are only temporary, particularly when there is a mismatch with the credit fundamentals. We believe a targeted, barbell approach is required to navigate current markets and capitalise on investment opportunities that can generate outsized returns".
However, inevitably with such opportunities come potential pitfalls. We believe that implementing a successful strategy in this context requires four critical elements:
- Deep sourcing and origination channels to identify attractive opportunities.
- Rigorous bottom-up fundamental analysis that can be conducted in a timely manner.
- Thorough documentation and legal environment due diligence.
- The ability to deploy capital opportunistically into compelling stories that may require time to play out.
In our latest insight, we outline the investment case for EM corporates through a locked-capital, draw-down vehicle lens and why we believe this approach offers an attractive risk-return profile.