Capital
Four US CEO and Portfolio Manager Jim Wiant recently sat down with Nedina
Stevens, head of ALTS Content with Markets Group, to comment on opportunities
across credit markets and credit strategies given recent changes in market conditions.
Jim
founded Capital Four US in 2021 to manage credit across strategies for
institutional investors. Jim joined from MidOcean Credit Partners in New
York, where he was a founding member and senior portfolio manager on a team
responsible for overseeing long-short credit opportunity funds, drawdown credit
funds, high-yield and bank loans, as well as structured credit investing.
Capital
Four is a $17 billion manager that invests across public credit, private credit
and hedge fund credit strategies. The firm manages capital for a diverse array
of institutional investors.
Markets Group: What are your views on market conditions as you think about
credit investing?
Jim Wiant: Credit markets are going through meaningful changes after a
protracted period of very accommodative monetary policies, which led to very
low global interest rates and spreads. With the sharp increase in
inflation to levels not seen in 40 years, we have seen an increase in interest
rates and spreads and a resulting slowing of demand, particularly with the
consumer. This presents what we see as a new investment paradigm.
By
way of example, the 10-year Treasury has gone from 1.51% at YE 2021
to a range of 2.81% to 3.47% over the past month. The Fed is
also signaling continued interest rate hikes of somewhere
between 1.5% and 1.75% over the balance of 2022, bringing
the terminal rate to a range between 3.25% and 3.5% by year-end. As a
result, we have seen loan yields rise from 4.2% at YE 2021 to
approximately 7.1% recently while the yield on high-yield bonds has
increased from 4.3% at YE 2021 to
approximately 8.6% currently.
Overall,
we believe the current yield environment which now compensates investors for
taking credit risk though credit selection is paramount given fundamentals are
weakening and the market remains turbulent with negative investor sentiment. We
are acutely focused on how companies and sectors adapt to this new environment.
MG: How would you describe the opportunity set for investors such
as traditional long-only credit, hedge fund credit and private credit?
JW: Opportunities in credit have not been this attractive in quite
some time given the shift to higher yields and the affect it is having on
issuers and sectors. However, risks will also increase given changing
economic conditions.
As a
result, we are finding traditional long-only opportunities more attractive
given higher yields and greater opportunities to differentiate among sectors
and companies. Clearly this is a market which favors deep fundamental
research and we see expanded opportunities in syndicated bank loans and high
yield. In addition, multi-asset credit, which entails investing across
credit asset classes combining bottom-up research with relative value views,
has a richer set of opportunities. This is driven by the fact that there
are pricing and risk discrepancies across issuers and credit asset classes.
Managing
credit in a hedge fund format presents increased opportunities as managers have
the flexibility to invest long and short and manage sector and fund-level
exposures dynamically. This also reflects the ability to invest across
credit asset classes, tilt the portfolio toward and away from sectors, combined
with trading opportunities. Shorting opportunities have also increased given
the impact of market conditions. We expect the opportunity set for credit
hedge funds to remain robust as higher rates and spreads impact issuers. With
macro conditions likely to be challenging for some time, credit long/short
presents an investment strategy well-suited to capture opportunities and
protect capital.
Private
credit opportunities continue to present attractive risk-adjusted
opportunities. With credit conditions tightening, opportunities in direct
lending should benefit. Less crowded direct lending strategies benefit
from higher rates (which tend to be floating) and higher spreads. Of
course, underwriting the impact of this higher-rate environment on the broader
economy, sectors and borrowers is very important. Direct lending
strategies which are secured, properly structured with collateral should
provide downside protection. Direct lending’s ability to generate higher
yields, resulting from customizing funding solutions, managing originated
credit assets and taking illiquidity risks, is an area we expect to continue to
provide investors with attractive return opportunities.
It is
clear we are in a new phase in market conditions and as a result, credit
investing is evolving. Each style of credit investing presents a different
take on opportunities.
MG: What do you see as the big risks in markets?
JW: The shift to more restrictive monetary policies and the resulting
slowdown in growth is just starting to flow through the economy and
markets. With consensus expectations for further increases in interest
rates, we believe that this change will only become more impactful on all
markets, including credit. This contrasts to the previous post-great
financial crisis market environment in which liquidity and access to credit was
highly accommodative, enabling companies to avoid defaults. A hard landing
in which tightening credit conditions lead to a global recession is the biggest
market risk. The depth and length of any such recession represents the key
risk consideration for markets and credit investing.
At
the issuer level, the impact of higher financing costs must be carefully
considered when underwriting credits. The increased cost of credit, and
the impact of a potential recession on a borrower’s ability to service and
repay debt, are the key risks.
This
means that credit selection becomes much more important in managing credit
portfolios to both protect capital and to maximize returns. These concepts apply
to all facets of credit investing – traditional long-only credit, hedge fund
credit and private credit.