Since July 2007, extensive credit market turbulence has created extremely challenging conditions for many credit asset managers, particularly those operating with leverage. Extreme spread widening coupled with a liquidity and funding crunch and deteriorating economic outlook has forced credit managers, from enhanced cash fund managers to hedge funds, to face an extreme stress situation.
In Europe, in particular, navigating the credit turmoil is all the more difficult for managers as credit only recently emerged as a mainstream investible asset class in a period of benign conditions. Until the beginning of the decade, European credit markets were dominated by bank lending and any capital markets activity was relatively fragmented and small. Post the introduction of the euro currency, the credit markets benefited from strong momentum and, after 2002, they were driven by a bullish sentiment awash with liquidity. This benign credit environment combined with favourable technical factors (such as inexpensive and abundantly available funding and very high demand for credit) fostered the development of leveraged, structured products long beta across the board.
At today’s level of spreads, credit markets have substantially repriced risk (both credit and liquidity), so that, even assuming no capital appreciation, the roll down and carry may offer equity types of return (absent a large upsurge of credit losses). However, the expected deterioration in credit fundamentals and increased default rates (notably in more leveraged segments of the market such as high yield (HY) and bank loans), combined with continued spread volatility and other near‐term uncertainty from unpredictable market technicals, continue to create a challenging environment for both buy and hold and total return managers.
We are currently seeing renewed selling pressure in lower quality credit markets, however better quality (A grade) credit was better bid recently, but ... Click on chart to enlarge, courtesy of Nordea Markets.
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