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Wall Street is protecting its debt market portfolios against inflation

(Bloomberg) – From fund managers at BlackRock and T. Rowe Price, to analysts at Goldman Sachs, to credit stores run by Blackstone and KKR, a new economic reality is driving the mightiest forces on Wall Street to adjust your investment strategies. The surge in inflation that will accompany the post-pandemic economic boom threatens to reverse the four-decade decline in U.S. interest rates, prompting a rush to protect the trillion-dollar value of investments in the US. debt market. It’s here: these companies and others are transferring money to loans and notes that offer floating interest rates. Unlike the fixed payments of most conventional bonds, those of floating rate debt increase as do benchmark rates, helping to preserve their value. “We have had a long 35-40 year period of falling rates that has been very supportive of fixed rates. investing in income, very supportive of the expansion of equity multiples, so for those of us who live and breathe investing, it has been a windfall on our backs for a long time, ”said Dwight Scott, global chief credit officer. Blackstone, which manages $ 145 billion of corporate debt. “I think we no longer have the wind at our backs, but we still don’t have the wind in our faces. This is what the inflation conversation is really about. ” To be clear, no one is predicting the kind of rampant inflation that rocked the American economy nearly five decades ago. However, many say that a subtle tidal turning is already taking place. Not since 2013, in the months before Federal Reserve Chairman Ben Bernanke triggered the so-called taper tantrum by suggesting that the central bank could start to slow the pace of monetary stimulus, have global bonds have Been under so much pressure to start the year, fueled by growing concern that price pressures are about to resurface amid a vaccine-driven economic boom, stifled consumer demand and another round of government stimulus, 10-year Treasury yields have soared more than 0.4 percentage points. Amid the turmoil, perhaps no market is attracting more attention than leveraged loans. Weekly flows to funds that buy that debt have already surpassed $ 1 billion three times this year, sparking further rumors about the foam, after failing to breach that threshold since 2017. The relatively high returns of the class of Assets make it an attractive investment for companies looking for the juice returns as the gap between Treasury rates and corporate debt narrows. At the same time, continued monetary and fiscal support from policy makers is expected to boost corporate earnings, helping them reduce debt multiples that soared amid the pandemic. However, what makes leveraged loans especially attractive to many is their floating payment stream. As the long end of the Treasury curve continues its dramatic rise, its lack of duration, or sensitivity of prices to movements in underlying rates, provides investors with significant protection, even in an environment where the Fed keeps its policy rate close to zero and the -End front anchored for years to come. “You don’t buy leveraged loans today because you expect the floating-rate component to go up,” said Lotfi Karoui, chief credit strategist at Goldman Sachs. “That is not the thesis. The floating rate component will remain stable for the foreseeable future. You buy it because the reflation issue is something that hurts the high-yield bond market more than the loan market. ” That’s not to say that junk bonds aren’t attracting their fair share of cash, too. The asset class can often be a safe haven from the threat of rising rates, as an improving macroeconomic environment tends to reduce credit risk, allowing spreads to tighten New issuance has reached a record pace to start the year, and the relentless pursuit of risky assets boosted yields on debt Given the strong growth prospects, Michael Kushma, chief investment officer of global fixed income at Morgan Stanley Investment Management, said he is comfortable dropping further in credit quality on B and CCC rated bonds to generate returns. The firm has also been adding exposure to leveraged loans “when it makes sense,” he said, noting that some clients are unable to keep debt in their portfolios. However, some say that record returns, even in the riskiest segments of the speculative-grade bond market, combined with the fact that average maturities have risen markedly over the past year, have increased potential risk and decreased the attractiveness of the asset class as a safe haven relative to lending. “We have increased our allocation to bank loans, in part by selling high yields,” Sebastien Page, head of global multiple assets at T. Rowe Price, said by email. “Put it this way: If we can get a similar return on loans and high-yield loans, on a risk-adjusted basis, the asset class that should perform better with rising rates (loans) looks more attractive.” Floating fever Not all asset managers can simply dial their credit risk, of course. For many, an alternative is the floating rate note market, a generally numb corner of high-grade credit with a fairly narrow buyer base. In recent weeks, demand has increased as investors seek to avoid negative total returns on fixed-rate debt. It is fueling a wave of new issues, including the first non-financial deal tied to the Overnight Secured Finance rate, the benchmark intended to replace Libor as the benchmark rate for hundreds of billions of dollars of debt to variable rate. “The big risk in the market really is inflation, whether it’s transitory or something more entrenched,” said Arvind Narayanan, Vanguard’s director of investment grade credit. “There is a tremendous amount of stimulus in the market, both monetary and fiscal, that favors economic growth.” Others are turning to more esoteric asset classes, including secured loan and private credit obligations, as they seek higher returns and more floating interest rates. Blackstone has increased investment in leveraged loans and direct loans over the past few years, and has accelerated change in the past month, according to Scott. He has also become one of the largest CLO administrators in the world. Western Asset Management has been increasing allocations to leveraged loans and CLOs, and continues to believe asset classes are an attractive opportunity, according to portfolio manager Ryan Kohan. The hiccup in the recovery could quickly affect inflation expectations and cause rates to decline. changes in the economy. “Inflation will be more transitory than sustained,” said Dominic Nolan, senior managing director at Pacific Asset Management. “We have to see how steep the curve gets and if the perceived inflationary pressures actually materialize into inflation.” However, many say that the Fed’s apparent tolerance for overshoot on the inflation front in the months and years to come makes this time different. It could very well be a prelude to inflation considering the current macroeconomic environment, ”John Reed, head of global trade at KKR, which manages some $ 79 billion in loan assets, said by email. “It seems likely that there will be a modest increase in rates from current levels for the remainder of 2021, but the Fed has been transparent in wanting the market to invest behind performance, growth and recovery.” (Updates with comments from Western Asset Management in paragraph 24). More articles like this, visit us at bloomberg.comSubscribe now to stay ahead with the most trusted source of business news. © 2021 Bloomberg LP

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