The lost art of credit analysis in buy and maintain

However, with geopolitical tensions and growing concerns around the credit market and economic environment, fixed income markets are facing increasingly uncertain conditions, and traditional buy and maintain strategies are being tested for the first time. It is also important to note that the average credit quality in the investment grade (IG) market has deteriorated markedly since the GFC, given the increase in corporates using bond markets for funding (rather than banks). With around 50% of corporates rated BBB, this in turn has increased the risk of rating downgrades from investment grade to high yield, along with the possibility of defaults.

In this macroeconomic landscape, the role of active portfolio management and rigorous credit analysis cannot be underestimated, in our view – not only as part of the initial credit selection process, but on an ongoing basis as economic conditions change, given the potential impact on underlying issuer credit risks.

Corporate balance sheets are under increasing pressure

Following months of monetary policy tightening, the hallmarks of a late credit cycle look to be taking effect in the UK economy. GDP growth is slowing and corporate leverage is rising, meaning higher defaults and downgrades could manifest over the next 12-18 months.

Though defaults are rare within investment grade credit, they are certainly not unknown and history has shown that companies’ fortunes can change quickly. Investment grade defaults have spiked during past credit downturns; notably the dotcom bubble in the early 2000s and the GFC in 2008. Neither of these events were ‘forecast’ and, as a consequence, significant damage was done to less resilient credits and to those whose business models had been predicated on continuity of access to short term funding, for example.