Careful evaluation becomes crucial in this market, where the potential for mistakes is higher. With the potential for default rates to climb to 8% or higher — according to MetLife Investment Management, sell-side institutions, and rating agency estimates — the market could get one in 12 credits wrong, Funk said.
Further, each of those mistakes can have an outsized impact on a portfolio — an unacceptable result in stable value — because default recoveries in COVID-affected sectors have been challenged during this cycle.
“How many downgrades can you sustain in an investment-grade portfolio and earn that back with a sub-2% all-in yield?” Funk asked.
Perhaps more prevalent for stable value performance is the potential for spread-widening related to rating agency downgrade risk. So getting ahead of high-profile downgrades is key. In this volatile and challenging investment environment, MetLife Investment Management believes investors should be seeking managers that have a defined track record in security selection and the expertise in portfolio construction to help mitigate some of this uncertainty, all underpinned by a fundamental research platform.
“When unexpected outcomes occur, resulting in difficult credit situations, we believe that our assessment of the issuer’s underlying quality and intrinsic value will be a critical driver of success during challenging time periods” Funk said.
That said, there may be more opportunity today, as markets have truly dispersed for the first time in a decade.
“We tend to think that volatility can be your friend if you’re resourced properly with the right people doing the right jobs,” Funk said. “Analyzing credit the right way is getting bad ideas out of client portfolios and good ideas into portfolios. We welcome the dispersion.”
Among the potential opportunities are fallen angels in the oil sector and some well-positioned consumer businesses, he said.
Regardless of sector, in every case, Starr, Funk and their teams look not only at a company’s fundamentals, but at the financial policy decisions that management is making. Such decisions might include how they’re dealing with historic dividend payout ratios or go-forward share buybacks, or what they’re doing as far as acquisition versus asset disposition.
“We think that’s where we can add a lot of value for our clients,” Funk said. “In some circumstances, management teams still control the fate of their outcomes, the fate of their balance sheet and the fate of their corporate credit rating. We tend to like those names.”
The approach considers continuously evolving business models that further complicate the landscape.
“We believe the need to generate safe and attractive income in a stable value portfolio places a significant premium on a process that features extensive fundamental credit research and is enhanced by building portfolios bond by bond from the ground up,” Starr said.
Funk agreed and added that he and his team are seeking to take advantage of investment opportunities even as the fundamental business outlook remains cloudy. “We’re excited about our ability to navigate these types of markets regardless of where we sit on rates, yields and spreads,” he said. ■
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