PLANSPONSOR - August - September 2022 - 9

Exploiting
Long-Term
Inefficiencies
In Today's
Credit
Markets
We examine the shifting
landscape across the US credit
markets and how long-term
active managers can try to
exploit the market's short-term
focus to add alpha.
By Robert M. Almeida, global investment
strategist, portfolio manager and Henry
Peabody, fixed-income portfolio manager
Generating Returns in Today's Market
* We're trying to generate above-average, riskadjusted
returns through a full market cycle. The
era of central bank activism has created very short
minicycles but also much longer economic and
full credit cycles.
* To generate returns, you must be cognizant of the
economy and the underlying fundamentals of the
companies that you want to own through a cycle.
This makes sense because your upside is your
coupon, and your downside is default.
* Investors can seek to amplify those returns
over time by taking advantage of behavioral
inefficiencies in the market-for example, by
providing liquidity when a particular security or
sector of the market is under stress. We believe it's
important to have core positioning around goodquality
companies that are going to potentially
reward investors over time and that investors feel
comfortable holding through bouts of volatility.
* Ultimately, the market's short-term focus offers
long-term investors a time horizon arbitrage,
which we feel is a very persistent source of alpha.
For example, despite fairly extreme central bank
activism and backstops for credit post-COVID, we
maintained a relatively low risk profile, not wanting
to be exposed to late-cycle credit with rich valuations
that likely have greater downside than upside
if the market stumbles. We feel that managers who
outperform in the short term are taking risks that
they're not being well-compensated for. In our
view, that's never a good long-term strategy.
* As bondholders, investors are lending money
to companies, and they need to understand how
willing and able the companies are to pay investors
back. If investors don't have a deep understanding
of fundamentals, they're gambling, and
that's not an investment strategy.
A Shifting Landscape
* We've had a generation of declining interest rates
and a half-generation of central banks fighting
deflation. This has made it relatively easy to
outperform over the past 30 to 40 years.
* More recently, we've seen bailouts and backstopped
credit markets as policymakers have
sought to prevent investor losses. The future will
likely be different.
* There's a shift underway from capital to labor.
The focus ahead will be less on central bank
liquidity and more on wages, organic growth and
consumption. Against that backdrop, if we don't
need capital markets to fuel people's portfolios as
much, maybe the Federal Reserve will step back
and protect investors less proactively.
* Over the next few years, what investors don't
own will be more important than what they
do. Overleveraged balance sheets, declining
The views expressed are those of the author(s) and are subject to change at any time. These views are for
informational purposes only and should not be relied upon as a recommendation to purchase any security
or as a solicitation or investment advice. No forecasts can be guaranteed.
MFS Investment Management; 51088.1
SPONSORED SECTION
PLANSPONSOR.COM August - September 2022 9
margins and rising labor and energy prices are
going to be major headwinds for companies that
are not prepared.
Tailwinds Turning to Headwinds
* For decades, globalization has restrained wages.
But that appears to be over now.
* The cost of capital is rising. We have to deal with
retooling and reshoring. Businesses will probably
need more working capital to invest in productive
capacity after years of focusing on financial engineering.
It's going to take time and be expensive.
If the demand for capital exceeds the savings rate,
we're looking at higher interest rates, a higher cost
of capital and potentially wider credit spreads.
* We think investors will need a good partner to
avoid these landmines.
Portfolio Positioning: Plenty of Levers
Left to Pull
* Broadly speaking, we're positioned to the lower-risk
side. We have room to add high-yield or emerging
market exposure, or go down in credit. There are
plenty of levers to pull.
* We're a big fan of providing liquidity in sectors and
names we like when we're paid to, and think the
banking sector may be one.
* One long-term trend we're looking at is electric
vehicles. While we might not own the bonds of
EV manufacturers, we can look for exposure via
suppliers to the industry. For instance, aluminum
component manufacturers
are benefiting from
vehicle light-weighting. It gives us exposure to
materials with a very secular and relatively low
capital-cost tailwind.

PLANSPONSOR - August - September 2022

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