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| Joe Biernat |
Biernat is director of research at ECM, a London-based manager with about €13.5 billion in assets under management. ECM was founded in 1999 and invests exclusively in European credit. Prior to joining ECM, Biernat was global head of credit research at BNP Paribas and before that built credit research teams at Deutsche Bank and Merrill Lynch.
What part of the market does ECM focus on?
We run 13 different funds and are focused on single-A and triple-B bonds, although we do have about €2 billion in high yield. Most of our investments are in investment-grade corporates and asset-backed securities. Earlier this year we launched a long-short fund, where we can invest in credit derivatives; however, this is only a small part of our overall strategy as most of our investors have a relatively low risk appetite.
Are you bullish or bearish on credit?
I'm very positive on the credit markets. I think the technical disruption we've seen will pass and it will pass more quickly than people are expecting. At some point the market will stabilize and people will jump back in. I expect it to snap back quickly, reversing most of the widening in just a day or two--so it's a question of picking up value while you can. A key date coming up is June 20th, when the iTraxx rolls. Typically you get a rally in the old series one week before and this could inject optimism into the market. That said, I think the storm clouds will pass even sooner than that.
What is driving the market?
Fundamentals don't mean a thing at the moment--it's technicals that are driving the market. If you take a look at net dealer positions in corporate bonds in March and April, you see that inventories spiked up to $6 billion in the wake of poor earnings and credit downgrades at General Motors and Ford Motor Co., over twice the level in 2002. Dealers have been sitting on all these bonds, possibly because nobody is interested in buying the bonds they have, or because the dealers aren't interested in selling at the wider spreads. This liquidity drying up is a significant part of what has pushed spreads wider despite good fundamentals. We've been trying to pick up value in the cash market but it's incredibly difficult because nothing is for sale in any meaningful size.
But now that spreads have widened, we expect the scales to tip back over the other way. Maybe I'm just being an optimist, but we've taken a look at upside and downside risks to credit and can only conclude that the positives look a lot better than the negatives. We're in a low-to-moderate growth environment with low inflation. Default rates are low and there are a few fallen angels but more rising starts. Ratings are for the most part stable, leverage is modest and corporate liquidity is strong--all this is favorable. And the key downside risks we identified earlier this year, including the GM and Ford downgrades, along with the unwinding of the hedge fund correlation trade, have already come to pass.
Which industry sectors are you focusing on in investment grade?
I'd highlight telecommunications and utilities as sectors with especially stable credit outlooks. In telcos, deleveraging is largely complete, with companies generating strong free cash flow. Alcatel, for example, is a good recovery play and will likely return to investment-grade status later this year. In utilities, the big spread movement is gone and the big gains from deleveraging are over but it is very stable. European retail, meanwhile, remains a much more volatile sector and investors need to be much more selective, which also provides the opportunity to pick value. As for autos, we were negative on GM and Ford a year ago already and it doesn't look like they're out of the woods yet. The luxury segment in Europe, on the other hand, is doing quite well, and Daimler Chrysler should not be dismissed along with the other two Big Three.
What is your outlook for high-yield spreads and issuance?
Looking at the long-term trend in yields, the recent widening we've seen is very modest indeed and doesn't even take us back to where the Merrill Lynch index was this time last year, which was itself a record tight level. So there's probably more widening in the cards. The primary and secondary markets are reflecting investors' risk aversion and while deals were getting more and more aggressive early this year with a lot of pay-in-kind issues hitting the market, we should see this dampen down somewhat.
Spreads are still tight in asset-backeds--where do you see them going from here?
It's interesting to note that asset-backed spreads move counter to corporate spreads. The spreads on triple-B U.K. residential mortgage-backed securities moved inside triple-B European corporates at the end of last year and the gap has widened markedly since then. While spreads are at record tights in most cases and tiering between asset classes has all but disappeared, we expect the tightening bias in the market to remain. We do see consumer credit fundamentals beginning to deteriorate, what with over-indebted consumers, house price corrections and so on, but within an allowable tolerance. Also arrears are rising in certain sectors, but not enough to worry us yet. Upgrades still exceed downgrades across the board, driven by good collateral performance and deleveraging.