Value and challenges in changeable markets

By Lars Tronsgaard, Deputy Managing Director, Folketrygdfondet.

The collapse in oil and commodities prices is hitting hard. Companies face declining revenues and tight liquidity in 2016, and more defaults and restructurings are to be expected.

It is surprising that these developments have not yet had a stronger impact. Default statistics from Stamdata show that the 12-month rolling default rate for the Nordic high yield (HY) market has been around 5 per cent or lower in recent years, although the Norwegian HY rate is currently slightly above this level, at 6.8 per cent, and the oil-related HY is at 12.1 per cent.

However, the number of credit events increased in 2015, to approximately 90, the highest level since 2009. Around half of these were real defaults. Nordic Trustee is currently working on more than 25 restructurings.

This is both good and bad news for bond investors.

The bad news, obviously, is that some corporate bond prices have fallen considerably, and demanding restructuring processes may therefore lie ahead.

The good news, on the other hand, is a substantial increase in future returns for companies who survive the crisis. This implies a better return on new issues, perhaps more in line with real credit risk than before the oil and commodities crisis struck.

Interestingly, credit margins have not only risen on securities with the highest credit risk. Even the most secure AAA covered bonds have experienced a material rise in credit margins. However, there is reason to believe that most of the margin increase is linked to the liquidity, rather than credit, premium.

Sharply declining liquidity is an international trend, not an exclusively Nordic phenomenon.

It appears largely due to the conclusion of several major players that stricter capital and liquidity requirements have made these activities unprofitable. International statistics show that the securities holdings of primary dealers have shrunk markedly, and are now close to zero.

The trend described above has both cyclical and structural aspects. Although it remains unclear whether bond prices will remain at current levels in the longer term, recent developments have underlined the need of market players with different portfolio strategies.

For long-term, counter-cyclical investors like Folketrygdfondet, shifts like the present offer interesting opportunities. It is important to adopt a portfolio strategy that successfully exploits time-varying risk premiums and a long-term perspective that allows liquidity premiums to be reaped.

Article published in Norwegian newspaper Finansavisen 12th January 2016.

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