Jeffrey Cucunato
on multi-asset credit

Mar 1, 2017
By Jeff Cucunato

Many fixed income investors have expanded beyond traditional broad market or investment grade corporate mandates via single-sector core-plus strategies. Although this allows them to keep control of their asset allocation, they give up the diversification benefits associated with being able to move dynamically within a wide array of credit sectors as risk appetite changes.

Multi-asset credit strategies are designed to target those benefits, which are likely to become increasingly important given the apparent shift to a reflationary regime and rising dispersion in asset prices now underway.

Jeffrey Cucunato, head of BlackRock’s U.S. investment grade credit team, discusses the applicability of a multi-asset approach in today’s markets.

Shifting drivers of credit return

Annual returns by asset class

Shifting drivers of credit return

Source: Barclays, Bloomberg and J.P. Morgan, as of December 31, 2015. U.S. High Yield = Barclays US HY 2% Issuer Cap. European High Yield = Barclays Pan-European High Yield USD hedged. U.S. Loan = S&P/LSTA Leveraged Loan. U.S. Investment Grade = Barclays US Corp IG. European Investment Grade = Barclays Pan-Euro Corporate USD Hedged. EM bonds = JP Morgan EMBI Global. IG CMBS = Barclays Investment Grade CMBS. Index performance is shown for illustrative purposes only.  It is not possible to invest directly in an index. Past performance is no guarantee of future results.

What accounts for the current interest in multi-asset credit?

The interest isn’t new, but I think it’s increasing as we potentially move away from markets where it was easier to be rewarded just for holding credit beta. Today, flexibility has become even more important. The multi-asset idea is to allocate to different assets globally wherever you see value. If you’re worried about rising interest rates, you can move out of rate-sensitive assets like investment grade and into high yield or loans. If you’re concerned about the turn of the business cycle, you can move the portfolio up in quality from high yield into investment grade. Within a sector or a geography, you aim to add alpha by tapping into the expertise of localized portfolio teams to help select individual securities and identify specific investment themes. At the same time, you can make adjustments to the overall level of risk in the portfolio, based on a macroeconomic view.

What’s your view of the current credit cycle?

We believe this is a very constructive time for credit, and especially for an active approach. The low rates that preceded the U.S. Presidential election helped attract interest from both sides of the risk spectrum. Some investors were pushing out from negative or low yielding government bonds because they needed more return. Others were concerned that policy-driven markets were artificially distorting financial asset prices and wanted to reduce their exposure to equities. Today, in the wake of Trump’s election we may be entering a new regime of higher growth and inflation as well as higher rates. Rates have already risen meaningfully since the election and we’re facing a new set of policy uncertainties. That has helped attract interest because it’s an environment that creates more winners and losers, and many investors feel active managers focused on relative value can take advantage of those opportunities.

Our view is that the credit cycle is now somewhat mature, especially in the U.S. We’ve seen some fairly strong performance in the credit sector in the last several months, and we view the default outlook as relatively benign as we head into 2017. We believe the cycle has room to run. At the same time, we still have a fair degree of uncertainty about the rate volatility that will follow future central bank actions.

How are these views shaping your strategy?

The uncertainty about rates would argue in favor of a larger allocation to loans, which offer some protection by virtue of being floating rate. But we also believe investors should have a meaningful allocation to high yield in order to capture the potential upside that might occur if economic conditions under Trump turn out to be more positive than markets expect.

We could see different opportunities further down the road. Depending on how the policies of the new administration evolve, we could see rising tariffs, which would hurt emerging market assets, or an economic expansion in the U.S., which would help them. Comprehensive tax reform or additional fiscal stimulus should be healthy for both growth and inflation, and they have the potential to further extend the credit cycle. But if protectionist policies start to hurt global trade and global capital flows and we’re not growing as fast, it wouldn’t be hard to tip this economy into a recession. Ultimately, we remain constructive on credit, but we’re somewhat cautious about potential risks to our outlook.

We also see dispersion as an important theme. A low volatility economy driven by monetary policy has bred low levels of dispersion in credit assets. A higher volatility economy driven by fiscal stimulus could generate greater dispersion in winners and losers and more relative-value opportunities. The continuing tech disruption of various businesses is also going to generate its own winners and losers. Finally, the growing adoption of passive fixed income strategies creates additional opportunities because passive investors don’t distinguish between good and bad companies. 

The enormous growth of the credit market in recent years has created a different set of risks and rewards. Larger markets mean a larger opportunity set. On the other hand, accommodative central bank policies and open capital markets have kept a lot of companies alive with relatively cheap debt. They’ve been able to extend their runway and improve their maturity profile, so they don’t have to face a big mountain of debt that would mature in the next couple of years, but they’ve also weakened their balance sheets. When we get the next default cycle, we may see lower recovery rates from these companies.

Ultimately, as we look across the landscape, we think it’s critical to have an active management style that has the potential to both uncover opportunities and also mitigate the risk from trouble spots.

What are some things to consider when investing in multi-asset credit?

It takes a lot of different resources to make this approach work. You need to understand the broad macroeconomic themes driving the market and determine the right risk allocations for you. You then need to combine this top-down analysis with an understanding of what’s driving the different sectors and regions and ultimately use the input from experts in particular industries and companies to help you make informed decisions about individual securities.

You need similar layers of expertise in risk management. The first line of defense is the credit analyst, who analyzes risk from a company standpoint. As a portfolio manager, your job is to focus on how the different risks aggregate up and interact at the portfolio level. You need to be aware if correlations or volatilities are breaking down or changing. And you don’t just want to look at things in terms of the current environment because risk models tend to be unduly influenced by recent events. You should have the ability to analyze how your portfolio would have behaved in other periods. Portfolio risks that appear very manageable today may look quite different if you analyze how the identical positions might behave in a more volatile period. Your risk management platform should also help you reduce the risk in your portfolio by identifying inexpensive hedging opportunities when they become available.

We all know that risks and opportunities shift along with the market. Multi-asset credit is an efficient and dynamic way to respond to those changes and capture the potential opportunities that arise.

BMSIX
Credit Strategies Income Fund A dynamic fixed income strategy seeking to invest in the best credit opportunities in search of high and steady income.
Managing Director, Head of BlackRock’s U.S. investment grade credit team