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Credit Market Insights: April Update From Ares Capital

By Richard "Crit" Thomas, CFA, CAIA
Income Investing
Credit Market Insights: April Update - Crit Thomas Interview

Crit Thomas:
I'm Crit Thomas, I'm with Touchstone Investments, and I'm here with Chris Mathewson, who is a partner with Ares Capital Management and is also one of the portfolio managers on the Touchstone Credit Opportunities Fund. And Chris, I'd like to start with just sort of getting your picture in terms of the background for the below investment grade universe, what's happening with spreads and the different types of securities that you can get involved with and then how all that is kind of informing how you’re positioning the portfolio.

Chris Mathewson:
Absolutely, happy to answer those questions. Good afternoon, everybody. What I would say is, look, there's obviously a perception that spreads are you know at all time, all time tights. And I'm just talking high yield for a second. And they are really tight. But I think it's really important to highlight the fact that the quality of the high yield market has changed over the last decade. There's actually a research piece put out over the weekend talking that if you quality adjusted the high yield market today versus a decade ago spreads would actually be almost 30 basis points wider than they are today. So in 30 basis points on a on a spread of roughly three hundred and twenty five. That's material. And it's really a function of the fact that you know 50, roughly fifty five percent of the high yield market today is double B versus if you rewind a decade ago, you know you had about 10 percent less with the bulk of that going into the triple C bucket. So you know I do think it's important to highlight the fact that it is a higher quality market.

And that's, that's really what's driving a portion of the spread, the low spreads that you're seeing. We do think that all spread markets, high yield loans as well as structured credit are attractive. Spreads should be tight in an environment like we're in where we believe GDP is going to grow, defaults are going to be cut in half really across the board. And you have significant amounts of monetary and fiscal stimulus across the globe.

So you know that's the type of environment where you're supposed to have tight spreads. And we actually think you're going to have further spread compression, particularly on the high yield side, but also on loans as well as structured credit.

Crit Thomas:
Alright, can you speak to the positioning of the portfolio? You have a lot of discretion in terms of what you can you can own within the below investment grade environment?

Chris Mathewson:
Yeah, absolutely. So how I would characterize the fund is we are overweight risk given this really favorable backdrop. We are overweight, high yield. If you are comping this to some sort of 50/50 loan high yield benchmark, we have about eighty one percent of the fund today in high yield, about eight percent in loans and the rest in rest in structured products and or reorg equities. And we believe that that is the right mix today. If you fast forward over the next three to six months, what I would say is we're probably going to be continuing to keep that significant overweight to high yield, but we'll probably be adding a little bit more structured products to the fund because we think that's a good way to play kind of the tail. The more discounted part of the high of the loan market in a diversified way, buying double B in equity within Collateralized Loan Obligations (CLOs).

Crit Thomas:
Interesting, so continuing to look forward, just thinking about risks and opportunities. What are some of the big picture things that you're watching for and that present itself that could influence spreads going forward?

Chris Mathewson:
Yes, so I think the two biggest risks to the market, as well as the fund in particular, I would say, are inflation, and I think you kind of have to lump inflation and rates together. But inflation being the biggest one, we all know that the headline numbers are going to be quite large over the next quarter or two, just given the base effect, the fact that we were all locked down last year and the prices were quite low for commodities, as well as just everything else that we were buying and selling.

If, if the Fed believes that we actually are going to have true inflation and expectations are kind of filling in there and they're forced to hike before the market expects, I do think that could be a potential source of volatility. That's not my expectation, by the way. But it is clearly one of the biggest risks out there. I think the second thing that I would highlight is a risk to the market as but more importantly to this particular fund is oil.

So the one area where we are playing the kind of reopening trade is in the energy sector. We've kind of passed on some of the leisure and gaming as well as the theaters. And we've decided to kind of put our chips down onto energy. And right now, OPEC plus is behaving, as are the shale exploration and production (E&Ps). But if that changes and the demand outlook changes, that could definitely impact returns for the fund. We do have some reorg equities in here on the energy side.

So that would bring some volatility in the fund if you saw production ramp up materially or if you had some sort of a pullback from a demand perspective, as you know, variance from Covid kind of pop up, whether it's in India or Brazil or for that sort of stuff.

Crit Thomas:
OK, well, that was very helpful. And I appreciate you taking the time. Thank you, Chris.

Chris Mathewson:
Absolutely. Really appreciate it. And hope everybody stays healthy and safe.

The Touchstone Credit Opportunities Fund invests in fixed-income securities which can experience reduced liquidity during certain market events, lose their value as interest rates rise and are subject to credit risk which is the risk of deterioration in the financial condition of an issuer and/or general economic conditions that can cause the issuer to not make timely payments of principal and interest also causing the securities to decline in value and an investor can lose principal. When interest rates rise, the price of debt securities generally falls. Longer term securities are generally more volatile. The Fund invests in non-investment grade debt securities, distressed securities and corporate loans which are considered speculative with respect to the issuers’ ability to make timely payments of interest and principal, may lack liquidity and have more frequent and larger price changes than other debt securities. The Fund invests in Collateralized Loan Obligations (CLOs) that have risks that largely depend on the type of underlying collateral. The Fund invests in equities which are subject to market volatility and loss. The Fund invests in foreign securities which carry the associated risks of economic and political instability, market liquidity, currency volatility and accounting standards that differ from those of U.S. markets and may offer less protection to investors.

The information and statements provided here are believed to be true and accurate. There can be no assurance however that the beliefs expressed herein will be consistent with future market conditions and investor behaviors.

This commentary is for informational purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy or a recommendation to buy, sell or hold any security. Investing in an index is not possible. Investing involves risk, including the possible loss of principal and fluctuation of value. Past performance is no guarantee of future results.

Please consider the investment objectives, risks, charges and expenses of the fund carefully before investing. The prospectus and the summary prospectus contain this and other information about the Fund. To obtain a prospectus or a summary prospectus, contact your financial professional or download and/or request one on the resources section or call Touchstone at 800-638-8194. Please read the prospectus and/or summary prospectus carefully before investing.

Touchstone Funds are distributed by Touchstone Securities, Inc.*
*A registered broker-dealer and member FINRA/SIPC.

Not FDIC Insured | No Bank Guarantee | May Lose Value

crit thomas global market strategist

Richard "Crit" Thomas, CFA, CAIA

Global Market Strategist
Crit is responsible for examining and evaluating economic conditions, generating insights and providing a sharpened perspective on investment strategies for enriched portfolio construction.

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