Conditions Appear Favorable for Distressed Credit Investing
Although the U.S. economy is in relatively good shape, we think there are headwinds in the outlook. Since central banks started hiking rates, the cost of capital for companies has risen sharply. This is happening at a time when inflation is still putting pressure on margins. have hindered companies’ abilities to access capital as traditional lenders pulled back on lending, and high yield issuance hasn’t recovered from highs seen a few years ago. Low interest rate pandemic era bonds and loans are maturing and companies are being forced to refinance at much higher rates or face the prospect of default. As a result, we expect investments in distressed credit to grow, and potentially show strong returns, as a result. Let’s take a closer look.
Distressed credit is the debt of companies that are experiencing stress, on the brink of default, or are already entangled in it. Volatility and uncertainty are key attributes of these markets, which often leads to a mispricing of assets. For an investor well-versed in managing the risks inherent in distressed debt, these mispriced assets can translate to higher returns relative to traditional performing credit. A meticulous and strategic approach can unearth the potential for high returns.
Stress has become particularly evident in Europe as rising interest rates, spurred by inflation and central banks, have taken their toll on the economy and availability of financing. Like in the U.S., high yield debt issuance has plummeted in Europe. As a result, some European companies are facing a coming due with no traditional ability to refinance. Distressed credit investors can move quickly to provide solutions to refinance or restructure debt in a way that is beneficial for the company, while investors could receive higher rates and more favorable structures.
In our 10-year Capital Market Assumptions outlook, we expect developed market equities to return 6.3% annually and global high yield to return 7.2% annually. Distressed debt funds have achieved significantly higher returns historically, and the returns have become particularly attractive at a time of stress when public market returns are depressed. As we haven’t seen conditions like this for distressed credit in more than a decade, it is hard to predict how the market will unfold. We think skilled credit managers with a thoughtful and disciplined approach to portfolio construction will likely have the most success.
Monetary tightening reduces the money supply in the economy, which may slow down the economy and reduce inflation.
Potentially Higher Return for Distressed Debt
As we haven’t seen conditions like this for distressed credit in more than a decade, it is hard to predict how the market will unfold. We think skilled credit managers with a thoughtful and disciplined approach to portfolio construction will likely have the most success.
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