Substantially dislocated industries are offering investors an adequate amount of incremental return, but it pays to look closely at the balance sheet before dabbling in volatile credit markets.
Rob Petrini, co-head of performing credit at Blackstone Credit says the firm is avoiding exposure to industries facing significant liquidity challenges, such as those who have suffered operational dislocation.
Blackstone Credit has also been reluctant to invest in industries where underlying secular trends have been disrupted by Covid.
“Where there are permanent changes in consumer taste and growth profile like movie theatres, for example,” Petrini says.
“We’ve had to work out what to put in the performing bucket and what we’re going to put in the stress bucket.”
During 2020, the market offered dislocation opportunities where companies were raising capital to combat operational distress or business model distress.
“We saw the premium we’d expect for more distressed or challenged investments also compress,” Petrini says.
Today, Petrini sees better opportunities in performing industries, with companies that have good growth profiles and are trending in the right direction. But because of the onslaught of demand for these, investors may be forced further out the risk spectrum.
When it comes to higher interest rates, Petrini says the advantage Blackstone Credit has it they operate with a floating rate across their strategies.
“So that portfolio yield would actually benefit from higher interest rates,” he says.
Pointing back to 2007, when rates were around 500 basis points libor, Petrini says life was easier and that worked to investors’ advantage.
But since we haven’t seen anything like that in a long time, from a new deal origination perspective, higher interest rates would dictate lower aggregate leverage levels driven by the company’s ability to support debt, from a free cash flow perspective.
“And that’s a good thing as well,” he says. “You have to be thoughtful about the impact to specific companies or business models or the economy, but as a pure variable, it’s actually a positive.”
Jonathan Sachs, managing director at GoldenTree Asset Management says interest rate volatility, something no one was talking about six months ago, is back on the agenda.
“Higher interest rates pose challenges for certain issuers trying to access liquidity financing and additional capital to avoid restructuring,” Sachs says.
“This also leads to potential spread widening and volatility, as we’ve already seen at the start of this year.”
GoldenTree has been active over the past decade looking at non-corporate situations that are distressed and independent of broader market and economic environments. These are either municipal situations, sovereign debt, or distressed structured products.
“For us, it pays to be ready for periods of volatility, and you want to have your funds positioned to deploy capital and react quickly,” Sachs says.
“However there aren’t specific triggers for us, we are looking for performing credit trades that are down due to some inflection point in the market.”
Sachs points out many companies have unsustainable balance sheets, irrespective of how much liquidity there is in the market, which sets up a sustained distressed opportunity over the medium to long term.
Eighty per cent of loan issuance year-to-date is single B rated or below, and coming off a year like 2020 where $140 billion in debt defaulted, there is still structural change going on in media, telecom, healthcare, and retail.
“These industries are independent of the Fed’s impact on the ability for these companies to withstand the pressures from a capital structure perspective,” he says.
“On a short term basis, interest rates might have reduced the amount of stressed assets that are priced on a stress basis in the market, but over the medium and long term, it’s set up quite nicely for a sustained distressed opportunity,” he says.