Short Credit: Our Answers to Investors’ Top Questions

Lord Abbett experts offer their perspective on key topics for investors in short duration and ultra-short bonds.

Amid the ongoing market volatility, Lord Abbett investment professionals have stayed in close contact with advisors and investors to provide timely perspective on recent events and their impact on portfolios. On March 17, Lord Abbett Partner and Portfolio Manager for Fixed Income Andrew O’Brien, Investment Strategist Joseph Graham, and Director of Product Strategy Stephen Hillebrecht held a webinar for professional investors on developments in the short duration credit space. (Register to view a replay of the webinar.) Here, these experts tackle a few of the most frequently asked questions from our audience.

What are you seeing in the credit markets?

Investment grade spreads have more than doubled year to date. Investment-grade spreads started the year under 100. On March 16, they closed around 225. Likewise, high yield spreads, which started the year in the 300s, have reached about 825. Those are pretty dramatic moves in relative terms. We've seen similarly volatile moves in a wide range of other fixed income markets, including commercial paper and floating rate notes.  

What about liquidity?

We're seeing some liquidity challenges as people have reassessed the post-pandemic world, their risk posture, and their current asset allocations. You can see that in a number of very specific instances that you can point to. If you look at “off the run” U.S. Treasury securities versus “on the run” Treasuries, for example, on the run treasuries have continued to trade with pretty narrow bid-ask spreads. But the slightly older off the run Treasuries have been trading with really wide bid-ask spreads and that's a classic sign of liquidity stress, since the credit standing is not a factor as both issues are U.S. government bonds.

We think it's too early to say now exactly how this will end up. There's still a very wide range of possible outcomes, and we’re certainly monitoring the course of the contagion. But the other important part is the response by governments and central banks. Depending on how these things shake out, we believe this could end up being a great buying opportunity—if the economic impact is not as great as feared, we might bounce back pretty quickly. But we still have to be open to the possibility that the government response may be hampered in some way.

There's been some unusual activity in the commercial paper market. What’s going on there?

That's been a particular area of stress over the last few days and it does seem to be much more liquidity-related than any fundamental risk being present. As coronavirus concerns heated up, you started to see traditional buyers of commercial paper step back a little. At the same time you saw issuers wanting to build a little bit of a war chest or kind of get extra liquidity on their balance sheet. So they actually went out and were initially trying to borrow even more commercial paper. That led to a classic supply/demand imbalance that caused a widening on commercial paper spreads. Some of that has gone away. You've seen companies draw down their bank credit lines instead of trying to issue commercial paper.

We think it’s good that the U.S. Federal Reserve (Fed) recognized that this was a liquidity problem, not a solvency problem. The Fed stepped in with the return of their commercial paper funding facility. We think that should be helpful, especially as the Fed has set up a facility where they can buy slightly lower-rated commercial paper as well. We think that should have a pretty quick impact.

With all the liquidity news, some people are getting flashbacks to 2008-09. What’s the comparison?

We think the Fed has gotten good at servicing the kinds of problems that emerged in 2008 when the locus is in the financial sector. And so a lot of what they've done thus far—two emergency rate cuts, opening up of the discount windows, and then opening up the dollar funding markets for overseas banks. All that is right out of the playbook of 2008. The issue now is that because these banks and other companies are hoarding cash, there's a bit of a log jam even though there's plenty of liquidity. There's plenty of money in the system, but getting that money to the actual companies has proven to be a difficult task but one that the administration, legislatures, and other governing bodies are well aware of and appear committed to solve.

With a shorter duration strategy that has the flexibility to invest across sectors, where are you seeing opportunities?

We see it as operating on two time horizons. The first is trying to take advantage of liquidity-driven disruptions. Here, you really have to see who's out there feeling pain and who wants to sell. We look at all the things that are for sale from these distressed sellers and see which ones fit our broad top-down views. We're seeing that primarily in things like the floating rate corporate bond market and also the bank loan market, for strategies that have the capability of going below investment grade and are willing to accept the lower liquidity of the bank loan market. The price drop in bank loans—the loan market's down more than 10 points over a very short period of time—presents an opportunity in an asset class that’s in general higher quality than a true high yield strategy. We’ve also seen select opportunities in corporate bonds, though you definitely have to be careful in choosing securities in some of the sectors that have come under pressure recently.

We've seen historically that when you have periods of volatility, different asset classes returned to normality at different paces—meaning some parts of the market may remain dislocated for longer. Be that as it may, it might be an opportunity for multi-sector strategies to rotate in and out of particular opportunities. We think that's a great opportunity for managers who can look out across the high grade, high yield, CMBS, ABS, and bank loan sectors.

How might diversification make sense at times like these?

That’s an important consideration for us as we build our portfolios, and we also believe it also extends to our investor base. Over the years in our short duration strategies, we've observed a lot of different kinds of investors, not just those who may be interested in improving their short term bond returns, but also investors who are looking to diversify from term risk—which, in our opinion, has never been a more pressing problem than today- and finally investors looking to reduce principal risk they might encounter with longer term, lower quality portfolios.

How might active managers respond in this situation?

Part of it is just at the heart of what we at Lord Abbett do—assessing, and reassessing, market and economic fundamentals; doing rigorous credit research; and really getting to understand the individual issuers. This is a tremendously volatile environment right now, but we think it’s a great time for an active manager. Volatility can be an active manager’s friend, even if it doesn't always feel fantastic every day. We're excited about the landscape that we see here, and we feel privileged to have the trust of our investors as we navigate this challenging time.