“Our lives are defined by opportunities, even the ones we miss” (F. Scott Fitzgerald)
I think the above title is apt for much of life, including the investment world, and the credit crisis was one such opportunity which served to make or break many mangers out there. A “broad-based” bet on parts of the fixed income asset class was enough to extract alpha. Now things are slightly trickier…
Investing is no longer a call on the asset class alone, but rather an emphasis on specifics is coming more into play. Spreads have narrowed, from their historically wide levels (see chart below from an excellent fellow blogger the Calafia Beach Pundit, Scott Granis, the former Chief Economist at Western Asset Management and Seeking Alpha certified) but Corporates are focused on managing and strengthening their balance sheets. Differentiation in returns can be seen between sectors and between names. Thus, the key going forward is credit selection and a focus on quality.
I remain cautious on the high yield space, concerned with the possibility of the default rate coming in higher than expected and with lower levels of credit available to struggling companies, the recovery rate disappointing on the downside. This again highlights the importance of being name specific when investing. With spreads narrowing as far as the above chart shows, the risk / reward profile of this part of the asset class is not as attractive.
INVESTMENT INSIGHT: Be name specific, focused on high-quality companies with strong balance sheets