Those carrying scars from 2022 could be missing out on supercharged income

"It's a great time to be in credit because we've actually got yield to play with. We've got an environment where we don't have to swing the bat too hard.

Looking at our performance, the fund that I manage in particular, has got an average credit rating of BBB-flat, so that's investment grade across the whole portfolio. The portfolio has generated 8.2% over the 12 months to July. So that just shows you’re able to stay in pretty high quality and generate just fantastic returns", says Strano. 

We manage roughly $4.5 billion of assets across everything from government and corporate bonds, through to loans and private debt-style assets.

We do a lot of credit work. Of the 10 in the Yarra team, seven of us have credit responsibilities in terms of analysing credit risk, quantifying that risk, and focusing on the relative value to ensure returns are commensurate with the risk that we're taking, and sizing the investment accordingly.

All the assets contribute to the portfolio carry. None of them are over-weighted from the perspective that they could detract significantly if something were to go wrong. So it actually adds a lot of defence. Looking at our credit portfolios, the average number of securities in there is 75-100, so there's a lot of diversity.

When thinking about credit, it comes back to the return over the risk-free rate and doing it in a way that gives you dependability of income.

Most of our portfolios are floating rate and we've done particularly well at navigating away from duration, which have affected the returns for a lot of traditional fixed income managers.

Having that kind of yield actually not only provides really good offence in terms of strong yields, but also provides really good defence from any kind of spread widening.

From our perspective, the prospect of seeing a negative return right now is just infinitesimally small. It's very hard to see how it can happen because you're looking at portfolios with an average spread duration of around three years and you've got yields around 7%. This means we’ll need to see credit spreads widen by a very improbable 250bps over a 12-month period to record a negative return. 

Right now, it's a pretty interesting market.

From our perspective, we think the RBA is on hold and will be so for a while before potentially cutting rates modestly in mid to late 2024.

We don't think that we are going to go into recession with expected growth at about 1.25% this year, then re-accelerating to about 2.5% next year. We may though have a per capita recession, with the biggest growth impetus coming from immigration. With circa 700,000 people coming in, this year and next boosting GDP, it then becomes a question on whether we grow on a per capita basis.

This cycle is playing out very similar to most cycles as occur in Australia where you've got households under pressure, and what do they do? They tighten their belts, but they prioritise their mortgage payments.

From a portfolio context, we are acutely aware of anything that's reliant on discretionary cash flow. So anything that's relying on discretionary consumer expenditure, we don't have much of that in the portfolios at all.

We're also very discerning in that private debt space. When I think about levered loans right now, there are quite a few that are exposed to the consumer who will be challenged from an earnings perspective, but they'll also have debt funding costs that have actually doubled, given they carry a lot of debt. They're credit quality is likely to be challenged.

We like the Residential Mortgage-Backed Security (RMBS) space. RMBS continues to come to the market and provide fantastic opportunities for high, risk-adjusted returns because we don't see the impetus for wholesale impaired structures in that space, because households are generally doing the right thing by meeting their mortgage repayments.

Especially on anything below AAA, you're getting paid yields of sevens, eights, even nine percent in some cases for investment-grade tranches, which require impairments akin to one and a half to two times what we saw during the GFC in the US. And that was accompanied by a 25% decline in house prices in the US. In Australia, house prices have been going up for the last five months.

The tier two space also looks incredibly attractive and we think that the REIT space, the REIT bonds in particular, will potentially look interesting. We think that REIT issuers will eventually be forced to come to the market, and it's likely to reset their curves in terms of pricing, and that would be an opportune time for us to allocate more capital to that space.

I'm expecting the consumer-related sectors would be probably more challenged, and that would be across sectors.

So whether it be levered loans that have business models that rely on discretionary expenditure, they're likely to be challenged. We're starting to see a couple of those that are having some residual issues now, and it's probably likely to get worse before it gets better, and some of those asset-backed structures will also potentially be challenged.

Aside from that, the commercial property space, which is something that people are acutely aware of, the private debt area, the mezzanine property lending that's gone on over the last five to 10 years, I think some of those structures will invariably become impaired.