Demystifying credit: a primer

Jun 5, 2018
By BlackRock Global Credit

Corporate credit provides investors with a wide variety of options to construct a strategic allocation with an attractive risk-return profile. Understanding the basics of this large, compelling universe is a key first step to sound investing in this asset class.

What is corporate credit?

Corporate credit is the amount of money extended to a company by a lender/investor so it can obtain what it currently needs (e.g., money to run or expand its business, money to repay maturing debt) and pay it back later. To incent lenders, credit comes with a promise by a company to compensate a lender with interest over and above the borrowed principal in the future.

What are the different types of corporate credit?

The various types available are: investment grade bonds, high yield bonds, bank loans and structured products.

  • Investment grade bonds are debt instruments generally carrying low to medium risk of default as determined by ratings agencies like Standard & Poors and Moody’s. To compensate lenders for taking on moderate risk they offer relatively moderate yields.
  • High yield bonds are issued by companies with a higher risk of default as rated by the same agencies and offer higher yields to compensate lenders for taking on more risk.
  • Bank loans are generally those made by banks to businesses, and may be secured or unsecured, the former requiring the borrower to provide collateral security in the form of assets (e.g., inventory, intellectual property) to cover against possible default on the loan.
  • Structured products such as collateralized loan obligations (CLOs), derivatives and credit default swaps offer investors further opportunities for accessing the asset class.

A third asset class

Corporate credit may be considered a third asset class alongside equities and fixed income (e.g., treasuries, municipal bonds), one with its own unique set of attributes. For example, equities tend to outperform in periods of strong economic growth, while fixed income typically performs best when growth is weaker. Corporate credit, however, is less tied to economic growth and more affected by borrower-specific risk. Historically, credit exhibits only moderate correlation with equities and minimal or negative correlations with government bonds, and thus can provide significant diversification benefits in a portfolio of equities and fixed income.

Correlations among credit sectors, sovereigns and equities provides diversification benefits (2001-2017)

Chart: Correlations among credit sectors, sovereigns and equities provides diversification benefits (2001-2017)

Barclays Capital, Morningstar, December 2016. Sovereigns = BBg Barclays Euro-Aggregate Treasury (USD hedged) Index; Treasuries = BBg Barclays U.S. Treasury Index; Municipals = BBg Barclays Municipal Bond Index; Barclays Agg = BBg Barclays Aggregate Index; Securitized = BBg Barclays ERISA-Eligible CMBS Index; Global IG = BBg Barclays. Global Corporate Index; EMD = BBg Barclays EM USD Aggregate Index; Ban Loans = S&P/LSTA Leveraged Loan Index; Global HY = BBg Barclays Global High Yield Index. Index performance is shown for illustrative purposes only. It is not possible to invest directly in an index.

The corporate credit market has grown exponentially in size, complexity, number of issues and geographical reach in recent years – in part due to global monetary policy driving investors to search for higher yields – offering a wide array of investable opportunities. With a broader, more global opportunity set to draw upon, investors can now look beyond a tactical allocation to this asset class and take a more strategic, long-term approach.

Global credit markets have grown ~3x and are more diversified and investible

Global credit markets have grown ~3x and are more diversified and investible

As of 12/31/17. Source: Barclays Capital, Morningstar

Corporate credit comes in two basic “flavors”: public and private. This generally refers to its liquidity after it has been extended (i.e., how quickly investors can convert their investment into cash in the future).

  • Public debt. High yield loans and bank loans, for example, which are traded at relatively high volumes by many different participants in the public market, are more liquid than some other corporate credit assets.
  • Private debt. Private credit, which tends to be more customized to its issuer’s needs, is typically traded at lower volumes within a more restricted universe of investors, if at all. In this sense, it is less liquid. While the public market is very large, the private market, which typically offers higher yields than the public market – to compensate for the complexity and illiquidity of its offerings – is smaller but growing as company financing needs are becoming too complex for public markets and investors increasingly search for higher yields.

Why invest in corporate credit?

There are several compelling reasons both institutional and retail investors may want to consider accessing corporate credit and making it a core holding in a diversified investment portfolio.

  • Higher yields. In the current low-yield environment, investors looking for yield may find corporate credit attractive as it has historically tended to outperform higher quality fixed income sectors.

Credit investments still offer the most yield

Credit investments still offer the most yield.

As of 12/31/2017. Sources Barclays Live, Morgan Markets, “MBS” = BBg Barclays Agency Fixed Rate MBS Index. “IG Credit” = BBg Barclays US Corporate Investment Grade Index. “EMD” = JP Morgan Emerging Market Bond Index Global. “Bank Loans” = S&P Leveraged Loan Index. “High Yield” = BBg Barclays US Corporate High Yield Index. “CMBS” = BBg Barclays CMBS Index. Indexes are unmanaged. It is not possible to invest directly in an index. Past returns are no guarantee of future performance. IG Credit, Bank Loans, and High Yield represent Yield-to-Worst.

  • Less sensitivity to interest rates. As monetary stimulus wanes, interest rates are poised to rise. In this environment corporate credit may be an attractive opportunity as it has tended to show less sensitivity to interest rates than investment grade bonds and government bonds.
  • Protection against defaults. Corporate credit is generally senior in the capital structure. This means, in the event a company defaults on its loan, corporate credit investors – as opposed to equity investors – are granted a priority interest in repayment.

Diversification benefits

Diversification benefits

BlackRock Investment Institute, September 2017. Risk-return data reflect BlackRock’s Q2 2017 capital market assumptions. Returns are geometric. See back page for additional disclosures. Contents of diversified portfolio are Global HY hedged (24.7%); $EMD (18.5%); Local EMD unhedged (18.5%); Global infrastructure debt (17%); Middle market private debt (12.7%); and RE mezzanine debt unhedged (8.5%). Proportions reflect the allocations in BlackRock’s Q2 2017 model portfolio for U.S. public pension funds.

Accessing corporate credit with BlackRock

Global corporate credit is made up of a large, varied and complex universe of assets. Perhaps even more than equities and traditional fixed income, it requires expertise to fully harness the potential of this asset class across strategies and throughout the economic cycle. An advantageous way of doing so may be through The BlackRock Global Credit Platform, which has the breadth, depth and scale to fully exploit the range of corporate credit opportunities available to investors.

There are many questions that can be answered by working with an experienced credit investment advisor such as BlackRock. Who should I lend to? Who should I not lend to? Do I want domestic exposure only or do I want to invest globally? How important is short-term liquidity? Do I want to invest in public or private credit? Do I use commingled funds (e.g., mutual funds, hedge funds, private limited partnership) or a separate account? What loan terms would provide additional protection to lenders, and how do I successfully negotiate those terms with companies?

Accordingly, it behooves potential investors in corporate credit to find a trusted partner with the tools and discipline to assess and structure offerings at all points in the economic cycle. This assessment needs to be performed with an eye not only to acquiring discounted or fairly valued assets across the broadest possible universe, but by employing a proven set of strategies for creating a risk-return profile suited to an investor’s needs.

The BlackRock Global Credit Platform combines global insight with local expertise, with 10 global offices and over 130 investment professionals including over 75 research analysts dedicated to researching global corporate credit at the strategy, industry and company level. This allows the platform to formulate macro themes as well as maintain a boots-on-the-ground ability to interview company managers to find the best new opportunities. With its globally integrated corporate credit team, The BlackRock Global Credit Platform manages to remain nimble and tactical across market opportunities throughout the economic cycle with a dual focus on generating sustainable results and providing downside risk mitigation. An advisor like BlackRock, with scale, robust top-down/bottom-up research capabilities and global reach can provide investors with the best opportunities for finding value at the strategy, sector, industry and company level.