Credit investors would be wise to reflect upon the growing debt burden weighing on the global economy.
According to estimates from the Institute of International Finance (IIF), global debt rose by $10trn (€8.9trn) in 2019 to $255trn. At the end of last year, global debt stood at 322% of global GDP, or 40% higher than before the 2008 financial crisis.
As a result of the unprecedented economic policies to deal with COVID-19 the stock of global debt will grow from these inflated levels.
Governments are raising debt as well as lending to corporations. Central banks are targeting low rates and buying both government and corporate bonds on the primary market, encouraging investors to participate in new issues in droves.
The IIF reckons that gross government debt issuance broke new records in March, rising to over $2.1trn, more than double the 2017-19 average of $900bn.
While governments are responsible for the largest share of the rise in global debt since 2007, non-financial corporate debt has soared, rising over 70% since 2007, to near 92% of GDP.
There is a consensus that such extreme policies are necessary to mitigate the effects of lockdowns on the world’s economy. Unfortunately, immediate action has to be prioritised, despite the awareness that growing the debt burden will mean putting future growth at stake.
Corporations loading up on debt may survive, but will have to divert revenues towards debt repayments instead of investing. This has implications reaching far beyond institutional portfolio management, but on a smaller level, it is a key consideration for credit investors.
While at this stage it may be possible to foresee which sectors will thrive in a post-pandemic world, investors will need to be careful when looking for opportunities.
This may sound like a platitude but in discussions with investors it is often mentioned how managers are pointing at price dislocations or distressed credits as opportunities.
The long-term effects of the COVID-19 crisis are yet to be fully understood. Solid credit investments must be hard to come by, and confined to sectors that can withstand further demand and supply pressures over the coming months. They are unlikely to be found in cyclical sectors or companies that already carry high levels of leverage.
Additional credit assessment and monitoring resources may be required to manage portfolios in this uncertain environment.
Investors need great discipline to avoid investing in credits that may soon become distressed. They should avoid credit strategies that rely on speculation rather than analysis.