Capital Four US CEO and Portfolio Manager Jim Wiant recently sat down with Nedina Stevens, head of ALTS Content with Markets Group, to comment on opportunities across credit markets and credit strategies given recent changes in market conditions.
Jim founded Capital Four US in 2021 to manage credit across strategies for institutional investors. Jim joined from MidOcean Credit Partners in New York, where he was a founding member and senior portfolio manager on a team responsible for overseeing long-short credit opportunity funds, drawdown credit funds, high-yield and bank loans, as well as structured credit investing.
Capital Four is a $17 billion manager that invests across public credit, private credit and hedge fund credit strategies. The firm manages capital for a diverse array of institutional investors.
Markets Group: What are your views on market conditions as you think about credit investing?
Jim Wiant: Credit markets are going through meaningful changes after a protracted period of very accommodative monetary policies, which led to very low global interest rates and spreads. With the sharp increase in inflation to levels not seen in 40 years, we have seen an increase in interest rates and spreads and a resulting slowing of demand, particularly with the consumer. This presents what we see as a new investment paradigm.
By way of example, the 10-year Treasury has gone from 1.51% at YE 2021 to a range of 2.81% to 3.47% over the past month. The Fed is also signaling continued interest rate hikes of somewhere between 1.5% and 1.75% over the balance of 2022, bringing the terminal rate to a range between 3.25% and 3.5% by year-end. As a result, we have seen loan yields rise from 4.2% at YE 2021 to approximately 7.1% recently while the yield on high-yield bonds has increased from 4.3% at YE 2021 to approximately 8.6% currently.
Overall, we believe the current yield environment which now compensates investors for taking credit risk though credit selection is paramount given fundamentals are weakening and the market remains turbulent with negative investor sentiment. We are acutely focused on how companies and sectors adapt to this new environment.
MG: How would you describe the opportunity set for investors such as traditional long-only credit, hedge fund credit and private credit?
JW: Opportunities in credit have not been this attractive in quite some time given the shift to higher yields and the affect it is having on issuers and sectors. However, risks will also increase given changing economic conditions.
As a result, we are finding traditional long-only opportunities more attractive given higher yields and greater opportunities to differentiate among sectors and companies. Clearly this is a market which favors deep fundamental research and we see expanded opportunities in syndicated bank loans and high yield. In addition, multi-asset credit, which entails investing across credit asset classes combining bottom-up research with relative value views, has a richer set of opportunities. This is driven by the fact that there are pricing and risk discrepancies across issuers and credit asset classes.
Managing credit in a hedge fund format presents increased opportunities as managers have the flexibility to invest long and short and manage sector and fund-level exposures dynamically. This also reflects the ability to invest across credit asset classes, tilt the portfolio toward and away from sectors, combined with trading opportunities. Shorting opportunities have also increased given the impact of market conditions. We expect the opportunity set for credit hedge funds to remain robust as higher rates and spreads impact issuers. With macro conditions likely to be challenging for some time, credit long/short presents an investment strategy well-suited to capture opportunities and protect capital.
Private credit opportunities continue to present attractive risk-adjusted opportunities. With credit conditions tightening, opportunities in direct lending should benefit. Less crowded direct lending strategies benefit from higher rates (which tend to be floating) and higher spreads. Of course, underwriting the impact of this higher-rate environment on the broader economy, sectors and borrowers is very important. Direct lending strategies which are secured, properly structured with collateral should provide downside protection. Direct lending’s ability to generate higher yields, resulting from customizing funding solutions, managing originated credit assets and taking illiquidity risks, is an area we expect to continue to provide investors with attractive return opportunities.
It is clear we are in a new phase in market conditions and as a result, credit investing is evolving. Each style of credit investing presents a different take on opportunities.
MG: What do you see as the big risks in markets?
JW: The shift to more restrictive monetary policies and the resulting slowdown in growth is just starting to flow through the economy and markets. With consensus expectations for further increases in interest rates, we believe that this change will only become more impactful on all markets, including credit. This contrasts to the previous post-great financial crisis market environment in which liquidity and access to credit was highly accommodative, enabling companies to avoid defaults. A hard landing in which tightening credit conditions lead to a global recession is the biggest market risk. The depth and length of any such recession represents the key risk consideration for markets and credit investing.
At the issuer level, the impact of higher financing costs must be carefully considered when underwriting credits. The increased cost of credit, and the impact of a potential recession on a borrower’s ability to service and repay debt, are the key risks.
This means that credit selection becomes much more important in managing credit portfolios to both protect capital and to maximize returns. These concepts apply to all facets of credit investing – traditional long-only credit, hedge fund credit and private credit.