Trends Watch: Investing in Credit

EisnerAmper’s Trends Watch is a weekly entry to our Alternative Investments Intelligence blog, featuring the views and insights of executives from alternative investment firms. If you’re interested in being featured, please contact Elana Margulies-Snyderman.   

This week, Elana talks with Sal Naro, Chief Investment Officer, Coherence Credit Strategies. 

What is your outlook for investing in credit? 

A conundrum: The economy is slowing while inflation remains sticky. At Coherence, we see dispersion among macroeconomic data points, which leads to dispersion in credit ratings and spreads and creates opportunities to drive alpha. 

The cost of capital, ultimately determined by central bank policy, drives economic growth and all capital allocation decisions – including corporations' CAPEX and M&A budgets, investor flows across asset classes, and global cross-currency flows. In a world of monetary policy uncertainty, further complicated by upcoming elections, geopolitical tensions, and indiscriminate fiscal spending, there will be 'haves and have-nots' that require an experienced, active manager to navigate successfully. 

The Fed needs to make a 50 basis point rate cut in September as a symbolic gesture to show it understands its policy is having a meaningful impact. However, we anticipate 'higher for longer' interest rates, a steepening yield curve, the default rate rising to 4-5%, increasing credit rating migration (both positive and negative), and a corresponding increase in dispersion between strong and weak companies/industries. The investing outlook is exciting. 

Where do you see the most significant opportunities and why? 

Coherence is positioned to continue taking advantage of short-duration financials paper (being refinanced at premiums), semiconductors and technology (levered to the boom in AI spending), metals and mining (benefiting from M&A and rising need for minerals like copper in an inflationary world), and Permian oil companies (as continued M&A, geopolitics, OPEC, and low US shale CAPEX budgets keep oil prices high in an inflationary world). 

Conversely, we prefer being flat to short telecom (affected by intense price competition and an acceleration of cord-cutting as customer wallets get squeezed by inflation), packaging (vulnerable to overall GDP slowdown and high price competition while input costs remain high), and chemicals (experiencing soft customer restocking due to slowing manufacturing and shrinking margins due to oil-based raw goods inflation). 

Bonds issued by higher-quality companies with solid credit ratings offer the best risk-return profile at the front end of the curve. As the risk-free curve begins to normalize to positive sloping, the front end will outperform as risk-free and corporate credit curves steepen further to account for the differentiation in company fundamentals and overall market uncertainty. 

What are the most significant challenges you face and why? 

The most significant challenge Coherence faces as a boutique investment strategy is growing our limited partner (LP) base. More capital would allow us to take advantage of the material opportunities we see in the markets and continue to drive alpha for our investors. We are aggressively looking to broaden our outreach and expand our LP base. The investing opportunity is among the best for actively managed credit in over a decade. Until 2022, easy money and zero interest rate policy were the high tides that lifted all boats—lazy long investing, obscure crypto projects, SPACs, and microcap high-growth tech stocks thrived. This period is firmly behind us. With ‘Higher for Longer’ rates, investors need to allocate to a true active manager now that dispersion and differentiation are beginning to accelerate. 

What keeps you up at night? 

With President Biden no longer in the running for the election, the Democrats' stance on key issues remains uncertain, adding to market volatility as the convention approaches on August 19-22. Investors are particularly keen to understand how the party's position on geopolitics, fiscal spending, inflation, the Federal Reserve's leadership, and taxation will change and how these compare to former President Trump's views. Markets dislike uncertainty, reinforcing our view of a ‘Higher for Longer’ interest rate policy. Additionally, the Fed's Jackson Hole Symposium, held on August 22-24 this year, has historically been where Jerome Powell has significantly influenced interest rate policy, causing substantial market movements. 

Those are the "known" risks. We don't know what is lurking, like the 'Monster Under the Bed.' The depth of the commercial real estate crisis is opaque, and the contagion can and will spread to the entire regional bank sector, which is a ticking time bomb for bank balance sheets. Adding to this is the ongoing potential for black swan events such as pandemic derivatives (bird flu, COVID variants, etc.), which have unknown impacts and further reinforce the need for more robust supply chains. Localizing and onshoring the supply chain has an inflationary effect, while most economic data in the U.S. is dramatically slowing down, creating the risk of stagflation or outright recession. 

The views and opinions expressed above are of the interviewee only and do not/are not intended to reflect the views of EisnerAmper.