Three years after the start of the increase in interest rates, cases of stress in the credit world are multiplying. How to position yourself in this context? Giacomo Calef, Country Head Italy of NS Partners explains this by underlining that last September, three years after the start of the massive rate increase cycle by the FED, the first cracks appeared in the American economy. Tricolore and First Brands suddenly filed for bankruptcy, causing hundreds of millions of dollars, if not billions, in losses to their creditors. Among them were major investors, including JP Morgan. Its CEO, Jamie Dimon, made headlines with a metaphor that went viral: “When you see one roach, there are probably others,” referring to recent developments in the credit industry.
Credit crisis, how to position yourself?
In October, two regional banks (Zions Bancorp and Western Alliance Bancorp) fell victim to potential fraud in the commercial mortgage market. Although the losses for these two institutions “only” amount to tens of millions of dollars, the impact is more significant given the small size of their balance sheets. In the wake of these apparently isolated cases, confidence in the financial system has been put to the test: the 74 largest banks in the country have collectively burned through 100 billion dollars of capitalization, signaling a potential slowdown in the economy.
Private credit managers are not all the same
The private credit market, which has experienced a phase of great liveliness in recent years, was immediately blamed. But in this industry, not all managers are the same. While some players are facing significant losses, others have so far remained unscathed.
In such a context, it is essential to pay maximum attention when selecting a private credit manager: the performance differences between the upper and lower quartiles can in fact be significant. It appears particularly important to favor managers with longer track records, i.e. those who have gone through several credit cycles, compared to those who have simply ridden the positive wave of this asset class in recent years. And if you are unable to do it yourself, it is essential to rely on an investment company that knows how to identify the best talent in the sector. Better managers, for example, are better able to distinguish between resilient issuers and those with a weaker credit profile due to excessive leverage, business models at risk of AI disruption, or other characteristics that might escape the less expert eye.
Alternatives to conventional credit and diversification
While at first glance they may cause concern, recent events could present enormous opportunities. Long-short credit managers, for example, may be able to stand out. Again, rigorous manager selection is essential, especially given the high levels of leverage of this type of strategy.
For those looking to avoid exposure to corporate and private credit altogether, there are still some attractive alternatives that offer similar returns with different types of risk. “Cat bonds”, for example, offer total decorrelation from the credit market, being instead exposed to natural disasters such as hurricanes or earthquakes. Finally, local currency emerging market debt, after a stellar start to the year, continues to offer fabulous returns, thanks to high real interest rates and attractive fundamental valuations of local currencies against the dollar.
Therefore, in the current context, manager selection remains a key factor, but not the only one. The ability to identify alternatives to conventional credit and to build diversified portfolios across different sources of risk also plays a fundamental role.
