Market Uncertainties Resurface Amidst October Turmoil
October has historically been a tumultuous month for financial markets, yet recent events have exacerbated prevalent anxieties. The heralding of bankruptcies in the United States, particularly that of Tricolor Holdings, followed closely by First Brands, has rekindled memories of the credit crisis from nearly two decades ago.
First Brands, an auto parts manufacturer burdened with significant debt, reportedly engaged in the dubious practice of double-pledging invoices to maintain liquidity ahead of its collapse.
Similarly, Tricolor, a subprime auto lender, faces accusations that cast doubts over the clarity and integrity of private credit markets.
As Jamie Dimon, CEO of JPMorgan Chase, ominously noted: “If you see one cockroach, there are probably many more.” This initial disturbance precipitated a decline in share prices among U.S. regional banks, culminating in a more extensive sell-off as credit spreads began to widen.
In a further complication, two notably smaller U.S. regional lenders—Zions Bancorp and Western Alliance Bancorp—reported their entanglements with substantial bad loans and allegations of fraud.
While these issues are primarily isolated occurrences within banks boasting market capitalizations under $10 billion, they invite eerie parallels to the regional banking vulnerabilities exposed by the demise of SVB in March 2023.
As risk appetites began to return, it remains prudent to reassess bond exposures.
Nevertheless, both banks subsequently reassured markets with provisions that were significantly less severe than anticipated, coupled with largely favorable earnings reports, which alleviated systemic risk concerns.
By the close of October, a renewed appetite for risk emerged, though a contemporaneous re-evaluation of bond exposures is advisable.
Strategies for Bond Exposures to Enhance Stability
Cushioning some of the market’s volatility is the robust condition of banking sector balance sheets along with a positive trajectory in credit growth, primarily attributed to lending from larger financial institutions.
However, the U.S. faces elevated delinquency rates on credit cards and auto loans, while the resumption of student loan repayments poses challenges to overall credit quality.
Rob Burdett suggests that a nuanced investment approach is essential under the prevailing circumstances. “It is time to illuminate the investment landscape,” he states.
Our current inclination, a conviction held for several months, is to maintain a core position within a judicious Global Strategic Bond fund, expertly managed to prioritize risk and return—the in-house team from Nedgroup Investments, led by David Roberts, Alex Ralph, and Matt Cornwell, meets this criterion.
For supplementary government bond representation, we incorporate a diversified portfolio of five iShares ETFs covering Treasuries, Gilts, and U.S. TIPS. These positions allow for tactical adjustments as market opportunities arise.
At present, any exposure to credit risk is channeled through investment-grade funds, which offer a buffer against volatility. This approach is bolstered by our selected manager, PIMCO, recognized for its cohesive and standardized investment methodology.
Where high-yield exposure exists, it is confined to short-duration debt, usually with an average term of around 18 months until the issuer’s repayment. This strategy enhances visibility on repayment prospects while concurrently mitigating interest rate risk.
Lord Abbett, a distinguished privately held firm with over five decades in high-yield investing, is our recommended manager in this category.
Our avenue for credit risk is restricted to investment-grade funds, which offers a commendable layer of protection.
We are also committed to the Colchester Local Emerging Markets Debt Fund, affording us access to well-capitalized emerging markets without exposing ourselves to USD volatility—a distinct advantage in the current year. Colchester, being an employee-owned boutique, is exclusively focused on government bonds.
Exploring Future Investment Options
We are contemplating the inclusion of a mortgage-based fund in the portfolio, but may defer this decision until the market settles.
Such a fund would benefit from floating interest rates, and the manager we are evaluating specializes in ‘seasoned’ loans—those that were issued prior to the global financial crisis, have withstood that upheaval, and now feature limited years until maturation. Historically, returns from such investments have proven to be stable and resilient.
In times when headlines regarding bond markets cast doubt on the reliability of interest payments and capital return, it is crucial to recognize the expanding universe of specialized bond fund opportunities available today.
With judicious selection, one can discover a bond as tenacious as 007, effectively avoiding any double agents lurking in the shadows.
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