Thanks to ultra-accommodative monetary policy, fiscal policy that’s stoking economic recovery, and improving economic data, credit markets are delivering for investors this year.
However, credit spreads – the yield premium investors receive for embracing corporate bonds over Treasuries – are tight. In some market environments, that can be cause for concern, but investors can guard against rough spots with active management. Plus, some professional investors believe credit market exposure is still warranted.
“Allocations to credit markets still make sense, but we believe that some caution and greater selectivity are warranted given the tightness of spreads,” according to T. Rowe Price research.
Investors new to the concept of credit spreads and the resulting premiums can get up to speed by focusing on three facets: credit quality, liquidity, and broader market risk. One way of looking at those traits is that there are times when credit market liquidity can become crimped, potentially weighing on corporate debt. Likewise, there are environments when credit quality is a premier factor – sometimes more speculative debt is in favor. Lastly, there are other times when investors should lean toward higher-quality fare. For now at least, it appears there exists stability for two of those three factors.
“Given the extraordinary amount of ongoing monetary and fiscal policy support, it could be argued that the liquidity and credit components are likely to remain stable or potentially even compress a bit further from here,” adds T. Rowe Price.
In what’s still a fluid environment, investors may want to embrace active management, particularly if they’re concerned about spread compression. While there have been notable tailwinds at the back of the credit market, fundamentals, broadly speaking, are languishing a bit due to industry consolidation and spending on shareholder rewards.
Another advantage of active management in this environment is that it can put investors in front of superior credit, strong fundamentals, and industry opportunities.
“We have a preference for shorter maturities, greater liquidity, and credits dislocated from fundamentals. In particular, we favor bonds from sectors that have suffered during the pandemic and could potentially be key beneficiaries of economies recovering, such as banking,” notes T. Rowe Price.
The firm recently filed plans for the T. Rowe Price Total Return ETF, T. Rowe Price QM U.S. Bond ETF, and T. Rowe Price Ultra-Short Term Bond ETF.
For more news, information, and strategy, visit the Active ETF Channel.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.