Navigating Investment Grade Credit with Goldman Sachs Asset Management
As part of our Spotlight on Solutions webinar series, our Global Head of Corporate Credit, Ben Johnson, and Portfolio Managers Ron Arons and Sophia Ferguson recently discussed how our investment team, process, and platform can help investors navigate opportunities in the deep and diverse US investment grade (IG) corporate bond market.
Q: The aggressive central bank tightening campaign led to broad-based weakness in financial markets in 2022. But 2023 has seen a change in tone: US IG credit has amassed inflows of $133 billion year-to-date.1 What should investors be mindful of going forward?
Sophia: The first thing to recognize is that the rise in bond yields over the past year has, in our view, created the most attractive environment for IG credit in years. The US IG market is currently yielding almost 6%. Income potential has only been higher than this 1% of the time over the past decade, underscoring just how attractive yields are today.
The second dynamic to appreciate is that we are in a new era for investments. The reorientation of supply chains, the decarbonization of more activities in more sectors and geopolitical uncertainty are some of the forces that suggest we are entering a more uncertain, complex, and volatile investment landscape.
Q: How are these new realities likely to impact IG credit investments?
Sophia: We see two key implications. First, we believe investors should restore allocations to high-quality fixed income assets like IG credit, which tend to be resilient to downside growth risks and volatility.
Second, we believe security selection will grow in importance. Our 21 IG research analysts across five locations conduct rigorous bottom-up analysis on over 850 issuers in the US IG credit market to uncover attractive opportunities for our clients’ portfolios.
But it’s important to recognise that our core investment philosophy of making the best use of our clients’ capital through active management and engagement with bond issuers does not change, despite the new backdrop.
Q: How do you put this investment philosophy into practice?
Ben: I recently celebrated 25 years at Goldman Sachs Asset Management and can therefore corroborate what Sophia said about the constants in our investment philosophy. When it comes to delivering on this philosophy for our clients, our people are our most important asset. We have more than 90 corporate credit professionals developing investment ideas across the IG, high-yield, and loan markets, and we also benefit from the insights of our broader Fixed Income team of over 300 professionals. Our global presence helps us locate investment opportunities across markets and regions, including dollar-denominated bonds issued by companies based outside the US—so-called Yankee bonds.
And not only are we a global asset manager, but we are also part of a global firm, meaning we benefit from intellectual capital across Goldman Sachs. Experts from the Goldman Sachs Global Markets, Global Investment Research and Investment Banking divisions often share their insights in our weekly Investor Forum and Quarterly Investment Meetings, deepening our understanding of capital markets and key investment themes like the energy transition.
Q: How has the investment platform at Goldman Sachs Asset Management evolved in recent years?
Ben: Digital transformation is critical to our firm, and we are continuously striving to deploy technology at scale to enhance our investment process. In fact, Engineering is the largest division at Goldman Sachs.
Our digitized research platform, Fluent, is one key innovation that we’ve been using since 2018. It connects proprietary insights with key financial and ESG datasets so we can develop and re-evaluate investment views faster.
Our Virtual Portfolio Manager—or VPM—is another key pillar of our digital toolkit. We implement around 10,000 trades daily on our fixed income platform, around 70% of which are now generated by VPM. This enables us to implement investment views consistently and efficiently across our clients’ portfolios, while reducing operational risk.
Q: What role do environmental, social and governance—or ESG—factors play in credit investing?
Sophia: Analysis of ESG factors enables us to identify both investment risks and opportunities, which is why consideration of these factors is firmly integrated in our fundamental research process. These factors can range from the energy efficiency of real estate to data protection breaches among telecommunications firms, which could lead to regulatory repercussions.
We assign a proprietary ESG rating to each issuer under our coverage, taking into consideration available ESG data, analyst research and insights from our engagements with company management teams. We engaged with over 1,500 issuers to discuss ESG issues in 2022 alone.
Importantly, our ESG rating includes a forward-looking momentum assessment. ESG data is often backward-looking—our momentum assessment helps give us an investment edge as an improving ESG laggard may offer more investment potential than a deteriorating ESG leader.
Fluent contains more than 250 ESG-related datapoints for each issuer, spanning everything from diversity metrics to energy transition targets, and information about controversies to industry sustainability ratings. We are continuously seeking to expand this dataset and our analysis as the regulatory and investment backdrops driving sustainability themes evolve.
Q: Higher rates and slowing growth have led to concerns about credit quality. What is your assessment of credit fundamentals?
Ron: The credit quality of US non-financial corporates is past its peak, but the speed and scale of deterioration have been limited. Data compiled from first-quarter earnings show that profitability, debt-servicing capacity, and balance sheet liquidity are still strong, and we expect this continued strength to be reflected in second-quarter results.
Notably, interest coverage ratios are double their late-1990s levels. What’s more, rating migration trends have been positive for ten consecutive quarters. In our view, this suggests that the attractive yields the asset class is currently providing are not a symptom of weakening credit quality or a rising credit risk premium.
Q: How are you positioned across the rating spectrum as a result?
Ron: While we prefer higher-quality assets overall—hence our preference for IG credit—we have a bias towards lower-quality bonds within IG itself given the attractive yields provided by BBB-rated bonds relative to their fundamentals.
The lowest-rated cohort within IG accounts for almost half the market and includes many issuers from non-cyclical sectors like utilities, which tend to be resilient to slowing economic growth. What’s more, many BBB-rated issuers appear to be managing capital conservatively, maintaining some cash flow after capital spending, dividend payments and share buybacks.
That said, we are mindful of idiosyncratic risks, including in Real Estate Investment Trusts, particularly in the office space which faces falling occupancy from changes in the way we work.
Q: Banks are among the largest issuers of IG bonds, accounting for 23% of the US IG market.2 How has the banking stress of March 2023 impacted your outlook for the sector?
Ben: We entered the year overweight banks in our US IG portfolios due to their strong fundamentals and attractive valuations and supportive technical dynamics as we anticipated a moderation in new bond supply relative to 2022.
Despite the isolated stress among US regional banks in March, we retain our constructive view on US banks’ prospects for three key reasons. First, they still have good access to liquidity. Deposit outflows have stabilized, and banks can source liquidity from various US Federal Reserve facilities. Second, large banks tend to have diversified deposit bases, unlike the banks that failed recently, whose concentrated deposit bases contributed to rapid deposit flights. The share of deposits covered by FDIC insurance tends to be higher at larger banks, which can also temper the pace and scale of deposit outflows. Finally, the capital buffers of systemically important banks generally exceed minimum regulatory requirements. These banks are also subject to greater liquidity, capital, and regulatory oversight than smaller banks.
Q: What are you closely monitoring in terms of the outlook for the banking sector?
Ben: We are mindful of two key headwinds: potential losses on loans as the economy slows, particularly in relation to commercial real estate, and the impact on net interest margins of higher deposit rates. That said, beyond the office sector, fundamentals in other types of commercial real estate are healthy and banks’ capital positions are strong.
Q: Lastly, is there room for credit spreads to tighten from current levels?
Ben: In short, yes, but only gradually due to both macro and micro considerations. On the macro front, we expect inflation to normalize further and labor markets to remain strong. At the company level, we think second-quarter earnings will show continued conservatism in terms of balance sheet management. As a result, we expect downgrades and defaults to remain in check, with any widening in spreads providing investors with an opportunity to increase their exposure to capture the attractive yields—or income—provided by IG credit.
1BofA as of July 21, 2023.
2Barclays US Aggregate Corporate Index as of June 30, 2023.
