Public debt and equity markets in the United States recovered from the coronavirus crisis so quickly that many institutional investors did not have a chance to react. However, less liquid private credit still offers opportunities to participate in the recovery.
Credit spreads have fallen to far less profitable levels in public credit markets, while some yields remain relatively high for private credit. Those higher yields can provide a cushion against losses and create the potential for gains.
Falling Credit Spreads
Nothing illustrates the speed of the recovery of public markets better than the decline of credit spreads. At the peak of the crisis in, the credit spread for high-yield bonds was close to 1,100 basis points. That was the highest level since the 2008 financial crisis. However, unprecedented Federal Reserve purchases in the high-yield market helped drive those spreads down. The credit spread for high-yield bonds fell below 800 basis points by late April and as low as 550 basis points in early June.
Front-running the Fed
Not all debts benefited from Fed purchases. For example, collateralized loan obligations with BB ratings still had spreads of 1,500 basis points as recently as late April. Mortgage bonds without government guarantees also continued to have higher credit spreads. The reason was obvious: the Federal Reserve was not purchasing these debts.
Many assets in emerging markets were also left behind. The Fed did not make extensive debt purchases in the emerging markets. Furthermore, most governments in developing countries were not able to afford significant stimulus programs. As a result, major markets in Latin America remained down 25% to 40% in U.S. dollar terms as of June.
At the same time, the S&P 500 was close to breaking even for the year. Depressed stock prices in emerging markets only scratch the surface of the opportunities available there.
A Margin for Safety
The higher yields available in the private credit markets provide a margin of safety for investors that is more in line with past data. Historically, investors have demanded higher yields as compensation for holding more volatile assets. Yet, we have already seen credit spreads retreat to relatively normal levels in the high-yield debt market. Credit spreads for high-yield bonds fell below 6% in June of 2020, less than 100 basis points above where they were at the beginning of 2019 and lower than they were in June of 2016.
We cannot predict returns with certainty, but volatility is serially correlated. The fact that high-yield debt prices moved significantly in the recent past makes them more likely to do so again soon. Private credit markets still provide higher yields that can reduce the impact of potential price declines.
A Widening Recovery?
If conditions improve, higher-yielding private debt also offers opportunities for substantial price gains. As economies around the world begin to reopen, some assets left behind in the initial rally have more potential to recover. The return of business is likely to help the beleaguered energy and transportation sectors.
On the other hand, the coronavirus crisis only accelerated the long-term decline of retail locations. Crucially for investors, many emerging economies are earlier in the coronavirus cycle. The impact of the virus may only be peaking now in those countries, so there is still a chance to take part in the recovery.
The Advantage of Private Credit
At this point in the cycle, private credit may be the only segment of the debt market with the potential for significant gains. Most U.S.-based debt that can be easily purchased in public markets has already received several trillion dollars of inflows from the Federal Reserve, reducing yields and limiting future gains.
Accessing appropriate coronavirus recovery investments in private credit markets demands considerably more research, but our efforts are justified by current market conditions. Contact Ashton Global to find the best remaining opportunities in private credit.
