Why this asset is due for a fresh decade-long boom

KKR's Jeremiah Lane shares insights from what we've seen so far in the credit markets, and what may be to come.
Hans Lee

Livewire Markets

If equity investors crave appreciating share prices, then credit investors long for great yield while taking as few risks as possible. 2022 was not one of those years for either asset class. But could 2023 be the start of a fresh bull run for investors who have been left in the doldrums due to central bank policy?

Jeremiah Lane of KKR argues that even though yields have fallen slightly, they remain at very attractive levels.

"We think spreads seem fair - they're not incredibly wide but they're not incredibly tight. They appropriately reflect the fact there is still uncertainty in the economy," Lane tells me.

In the high yield market, the income opportunity is even larger with Lane explaining that the returns are at the high end of trends we've seen in the last ten years.

All this is happening as the question over a US-led global recession remains up in the air and some major money managers continue to hold an underweight call on risk positions. 

In this, the first of a brand new trio of Expert Insights, Lane shares his views on the credit market's early performance so far and where he thinks the multi-year opportunity will come from.

Note: This series of videos was taped on Wednesday February 8th 2023.


LW: How have credit markets started 2023?

Lane: I think that the credit markets have started the year strong. When we started the year, we were looking at available yields in the bond market of around 9% and available yields in the loan market around 10%. And they've both come in a bit to start the year, but we still see the market as very attractive. 

When you look at the market based on spread, based on available yields and based on price, we think that spreads seem fair. They're not incredibly wide, but they're not incredibly tight. They appropriately reflect the fact that there's some uncertainty in the economy, but when you look at the available yields and the available prices, they're actually quite attractive. 

And the yields that we can get in the high yield market today are top decile. Over the past 10 years, there have been moments where you could get a bit more yield, but certainly not a lot more.

There have been moments where you could enter these markets at lower dollar prices, but not a lot of moments. And so we think it actually sets up pretty nicely and we think that you can earn a fair return and we think that there's enough excess return that you're protected in case there's some economic uncertainty as the year progresses.

LW: What effect did rate hikes have on valuations?

Lane: The changes in the Fed last year were massive and they were a persistent headwind for the market. When you go back and look at forecasts that were coming out in January of 2022, most economists were calling for three, maybe four interest rate hikes over the course of 2022. Fast-forward to the end of the year and we had multiple individual meetings where the Fed was raising rates by 75 basis points in that one meeting. 

The market was really off offsides at the start of the year, and there was a really huge adjustment that took place over the course of the year, and that was a very persistent headwind. That was really why we saw the high yield market sell off as substantially as it did. People continuously were playing catch up.

On the loan side, the response was more muted. Loans have much less interest rate sensitivity embedded in the product. As the fed raises rates, loans get more income, their floating rate. But we did see some pressure on loan prices that really stemmed from the CLO market. And in the CLO market, CLOs borrow a lot of money from banks and over the course of the year, as the banks took losses in their government bond books and their investment grade bond books, they had less capital to allocate to new CLOs. 

Because they were allocating less capital, they were able to charge more and then in turn, loan prices had to fall to make up for that higher cost of funding. So we saw loans also weaker over the course of the year, but much more muted. Total return for loans, ended up down low single digits for the year.

LW: How are KKR preparing portfolios in anticipation of a recession?

Lane: We would say that there's an elevated possibility of recession. I don't think that we're to the point where we're saying it's a certainty that there's going to be a recession later this year or next year. I do think that the Fed is going to continue to try to put the breaks on what's happening in the economy. Last week we saw a very, very strong jobs report number on Friday. As soon as that jobs report number came out, the market's expectation for the speed with which the Fed would stop hiking came off.

And people are now expecting the Fed to raise more, potentially hold at a higher level for longer. I do think that that's a headwind. I do think that that's going to weigh on corporate earnings. 

I'm not at the point where I'm saying that it's a certainty that there's a recession. The US is sitting at mid 3% unemployment. Frankly, the economy's still quite strong. So I think there would have to be a lot of weakening from here to get to the point where we were truly in a recession. And I think there's an opportunity for the Fed to thread the needle.

LW: Why will credit have a better year than equities?

Lane: We think that it's a really attractive time to invest in credit. And when we look at the yields that are available in credit versus the yields that have been available for the last 10 years, there's a lot more yield available in credit today than there has been for a long time. And so I just don't think that equity is set up in the same way as credit, where in credit, there's really an outlier opportunity to earn return current income and appreciation in the year or two ahead. I don't think that that same opportunity exists in equities. Equities look richer to us.

When we look back at moments of market recovery, we see a bunch of different patterns. You go back to COVID and you see very, very rapid recovery over the course of 2020 and bleeding into 2021. But really most of the recovery happened within six or nine months. When you go back to the energy selloff in 2015 and 2016, you saw a couple years of really nice returns. I think that what will be different about this time is that we do not expect the Fed to return to zero interest rate policy. 

And to the extent that the Fed is maintaining a more normal Fed funds rate over the next five or 10 years, I think there is an opportunity to just have persistent substantially higher yields than what we've seen really since the financial crisis. And I think that's the scenario that we see that could really play out over many years, potentially a decade or more.

Learn more about investing in credit

KKR Global Credit Opportunities Fund (GCOF) provides investors with exposure to KKR Credit's flagship opportunistic credit strategy in an Australian unit trust hedged to AUD.

For further insights from one of the world's most recognisable names in private equity and alternative investments, visit the GCOF website

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Hans Lee
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Hans is part of Livewire's content team. He is the moderator and creator of Signal or Noise. He also writes the LW-MI Morning Wrap on Tuesdays and Thursdays.

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