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Credit Events 2023 In Review

Destra Capital

January 8, 2024

Eighteen and Oh!

18 & 0 sounds like the start to a magical college basketball season and maybe the Houston Cougars get there in another week or two….but that number also reflects the magical results of Destra’s Credit Strategies Indicator (“CSI”) for all of 2023. Every one of the eighteen subcategories in the CSI finished last year in positive territory with the average in double digits at 11.18%.

Wow, what a difference a year makes. The CSI averaged a -9.99% for 2022 with only 2 of 18 categories positive for that year.

Destra’s Credit Strategies Indicator 2023 2022
Convertibles 11.12 -19.84
Structured Credit Senior 10.76 0.43
Structured Credit Junior 19.33 -6.75
U.S. High Yield 11.93 -10.30
U.S. Investment Grade 6.55 -14.62
International Investment Grade 10.55 -18.53
International High Yield 15.03 -12.44
Preferreds 7.20 -15.93
Municipals - High Yield 6.17 -12.85
Commercial Mortage Backed Securities 4.59 -10.81
Mortage Backed Securities 5.03 -11.81
Municipals 6.43 -9.13
Emerging Markets - High Yield 9.77 -12.52
Emerging Markets 10.74 -12.99
Senior Loan 13.25 -4.64
Interest Rate Hedged 11.54 -1.18
BDCs 28.57 -8.72
Event Driven Credit 12.74 2.83
Average 11.18 -9.99

BDC Investing
The top CSI performer for 2023, by a country mile, was the BDC sub-strategy up an astonishing 28.57%. BDCs are unique investment vehicles that (primarily) make loans to small and medium size business across the US. Many BDCs are listed and their common shares trade on exchanges. Some BDCs are offered over-the-counter, as they are technically a closed-end fund, but otherwise their similarities to mutual funds end there. The business of investing in BDCs stretches to ETFs, CEFs, and mutual funds that specialize in assembling portfolios of different BDCs and the benefits to having exposure to these credit structures paid off big last year.

Junior Tranche, Structured Credit
Structured Debt with a focus on Junior Tranches was the second best performing sub-strategy in the CSI for 2023, up 19.33%. Not unlike BDCs that took the top spot, this CSI sub-category is also squarely a “non-traditional / alternative credit” category. Structured Credit typically involves securitizations of other debt instruments and the subsequent tranches of the structure typically have senior and junior levels. The more junior the level, the greater amount of credit loss and impairment the tranche has to bear when things go wrong. But the trade off is the greater amount of return (cash flow) that is credited to the tranche when things go right. And things went very right for these junior tranche investments and the funds that specialize in investing in them in 2023.

Leveraged Finance
Most leveraged finance instruments (high yield bonds and senior loans) performed admirably in 2023. In the CSI, the International High Yield sub-category performed best up 15.03%, followed by Senior Loans at 13.25% and then US High Yield at 11.93%.

Real Estate Associated Debt
The underperformers for the year were the Commercial Mortgage Backed Securities sub-strategy up only 4.59% and the more retail home oriented Mortgage Backed Securities sub-strategy up 5.03%. Clearly, the worry about rising mortgage rates led to concerns about mortgage delinquencies increasing.

Financial Capital
Preferreds should be noted as a one of the most interesting sub-categories in all of 2023. Rising rates to start the year triggered a full scale, though short lived, banking crisis. Several medium to large size regional banks in the US went under, most notably First Republic and Silicone Valley. Across the pond in Europe, one of the largest, oldest, most storied financial institutions in history fell into the arms of its rival, when Credit Suisse was unceremoniously married off to UBS by the Swiss regulators. Understandably, Preferreds tanked through the firsts 8 months of 2023, but then came roaring back, up more than 20% off the bottom to finish the year at 7.20%, in 12th spot in the CSI.

2022’s Top Performer: Event Driven Credit
Event Driven Credit was up 2.83% in 2022, making it far and away the best credit strategy to have been invested in that year, when the CSI average was down -9.99%. Often a strategy or investing style, might be in favor in one year or market environment but then not perform as well in a different one. Yet Event Driven Credit delivered well in 2023, up 12.74% coming in as the 5th best performing sub-category for the year. Like a lot of alternative strategies, the dynamics that drive performance in event-driven credit type investments are more idiosyncratic at a company by company level and are less impacted by macro forces like rates and GDP. This means that results can be expected to be driven more by the ability of the investing team to execute their strategy, than be the general forces shaping overall income markets around them. That is what makes the idea of diversifying into alternative capabilities so appealing, that chance to add diversification and non-correlated sources of risk and return.

2024 Credit Markets Ahead
Through the first week of the New Year, Bloomberg Agg was down some 120 bps, and there is a lot of chatter about profit taking in credit markets, after such an amazing bond rally to end 2023. Maybe that is the case, but every financial pundit and major news source is suggesting that we may see a huge rebalance into bonds as investors reallocate in advance of expected Fed rate cuts later this year.

Time will tell if the Fed actual moves as fast as the markets are predicting and if the resulting impact on bond and debt markets is as positive as the prognosticators predict.

Here at CreditEvents we just report the facts to you each month, as they are measured and play out in the Destra Credit Strategies Indicator. But we can still be hopeful as we look to the New Year, that we might have another magical credit investing season ahead and perhaps go 18 & 0 one more time!!