The UK pension upheaval last year and more recent US regional bank stress may be just the beginning of rolling crises that end up in a global credit crunch, according to Janus Henderson Group Plc.
The two episodes in a world of elevated interest rates may lead to constrained credit, increasing defaults and crimped corporate profits, said David Elms, who manages $3 billion across 11 funds as head of diversified alternative strategies for the money manager in London. “I would be nervous about credit given the benign credit landscape we’ve had in the past 15 years.”
UK pension funds were battered last September after then prime minister Liz Truss announced a round of unfunded tax cuts, that led to a slide in gilt prices and a vicious cycle of collateral calls. Several regional U.S. banks collapsed in March, setting off a slide in bank stocks around the world, as rising Federal Reserve interest rates sapped their liquidity.
Increasing defaults in junk bonds are further evidence of underlying threats to financial markets, Elms said in an interview last week. “If we look bottom-up, high-yield defaults look quite daunting. There is considerable risk when it comes to earnings and defaults.”
“Higher interest rates tend to break things,” he said. “We don’t want to take much risk in areas we don’t have a competitive advantage.”
Fidelity, Allianz
Elms is just one of a growing number of investors who are uncomfortable with the effects of rising global borrowing costs, and their impact on companies least able to service their debt.
Fidelity International global fixed-income chief investment officer Steve Ellis and Allianz Global Investors portfolio manager Mike Riddel both this month expressed concern that tighter monetary policy will lead to a recession, and weigh on credit markets.
Global high-yield defaults will rise to 5% early next year, in excess of the 4.1% long-term average, Moody’s Investors Services forecast last week.
Value in AT1s
One area in which Janus Henderson’s Elms sees value — and has been buying — is additional tier-1 bank debt issued by European lenders.
The relatively high-risk debt securities tumbled in March after Swiss authorities that brokered UBS Group AG’s takeover of Credit Suisse Group AG wiped out the latter’s AT1 bond investors, while preserving some of the value of its shares.
AT1s have rebounded more than 10% since Credit Suisse’s rescue last month, according to a Bloomberg index, rewarding the likes of Elms and others who were attracted to the beaten down securities.
“People bailed out of a lot of bank debt, including AT1s,” Elms said. “We had never really seen the value of AT1s. We had never held them because they were priced at a level in which the likelihood of that event was extremely low.”
--With assistance from Garfield Reynolds and Tan Hwee Ann.
