Astra Asset Management is a reputable investment firm based in London, specializing in corporate credit markets and asset-backed securities. Co-founded by Anish Mathur and Christian Adler over a decade ago, the firm has extensive experience in the industry. In this article, Christian shares valuable insights on various investment instruments in corporate credit, the relative value among these instruments, and how Astra effectively captures value in the current macro-economic environment.
The European bond market has witnessed a strong first quarter in 2022, with corporate debt raising EUR 260bn. High yield issuance has also increased by over 20% since Q1 2022. With such a diverse range of options available in the corporate credit market, investors have numerous opportunities to express their ideas. However, before diving into individual issuers’ credit quality and corporate balance sheets, investors must decide which form of exposure they prefer: bonds or loans, investment grade or high yield. Additionally, they must consider the pros and cons of selecting individual issuers versus investing in a pool of assets, such as a collateralized loan obligation (CLO).
Bonds and loans differ in two crucial aspects. Firstly, corporate loans are typically senior secured, while bonds are unsecured, leading to variations in recovery prospects in case of default. Secondly, loans are usually floating rate, whereas bonds predominantly have fixed rate coupons. Depending on an investor’s view, the shorter interest rate duration of loans may be preferable in a “higher-for-longer” scenario, while bonds’ longer duration may be favored by those anticipating a fall in long-term rates.
A crucial factor to consider when investing in corporate credit is the credit rating. Leveraged loans and high yield bonds generally have credit ratings of BB+ or lower, indicating a higher probability of default and increased idiosyncratic risk compared to investment grade instruments. To mitigate this risk, investors can opt for highly-rated bonds or exposure to a pool of credits, such as CLOs, which provide structural support and protection against default.
When assessing the quantitative aspects of various credit sectors, risk premia play a significant role. Financial markets, particularly credit spreads, have a dynamic nature. However, analyzing historical trends can provide valuable insights. CLOs backed by leveraged loans offer higher yields than individual loans, and the BB-rated tranche provides structural protection and reduced idiosyncratic risk. For investors seeking additional leverage or an investment grade rating, BBB CLOs are a suitable option. These tranches benefit from higher original subordination and have minimal risk of principal loss.
Comparing loans to high yield bonds, the latter demonstrates greater sensitivity to medium-term interest rates. However, total returns over the past decade have been similar. Whether loans’ recent outperformance is sustainable remains to be seen.
Credit derivatives have evolved into useful tools for hedging and trading. Credit default swaps (CDS) were initially introduced to hedge exposures on financial institutions’ balance sheets. Hedge funds also utilize CDS to express directional views on issuers or place bets on the relative value of different parts of a company’s capital structure. Indices representing various corporate credit segments offer investment opportunities and serve as hedging tools.
In conclusion, the corporate credit market has evolved significantly over the past two decades, providing financial institutions and investors with innovative solutions to meet their investment objectives. However, due to its complexity and size, the market remains somewhat compartmentalized, resulting in inconsistent pricing of similar risks in different segments.