Transcript:

We’ve seen a lot of quantitative easing by the Fed. Rates are already at zero, and there’s been a lot of fiscal stimulus that’s been pumped into the system. And, so, folks are very concerned about inflation continuing to run hot, which could create pressure for rates to rise. And, if rates rise, you really don’t want to be in very interest-rate-sensitive bonds in general.

And, so, investors today are much more concerned about earning a big enough return on their money to overtake that potential degrading value from prices moving higher—or inflation in general. So, when we think about ways to try to mitigate that risk, we think you’re much better off in this environment, taking more credit risk and less interest-rate risk. Companies are in good shape. They’ve refinanced a lot of their short-term debt, their growth potential is pretty strong, their earnings are strong, and for that reason you’d want to lean more into credit.

Now, not all credit is created equal, so we think there’s a very good reason to be shorter in your duration holdings. We talked about some of those rate fears, so that’s one of the big reasons. And then another thing to really focus on is: What’s the quality of the companies that you’re lending to? And we think in this environment, given where valuations are overall, you’re better off leaning more into quality credits that are shorter duration in nature.

And, in today’s dynamic, the US assets in general are actually fairly expensive compared to the rest of the world. And, when we say US assets, I’m specifically talking about US credit assets. So, if you have the flexibility, we’d recommend adding in some securitized assets to give you more of a diversification benefit, but then also looking outside the US, looking at Europe, at Asia and in parts of emerging markets where we think that there are better valuation opportunities. And when you combine that with corporate credit in the US, you have much better outcomes over the long term.

The same principles apply when we move outside of just US corporates, in that—if you can focus on higher-quality companies and countries on a shorter part of the yield curve—your risk-adjusted returns are actually much better. When the reality is you have a really nice, what we call, capture ratio, so you get a decently high percentage of the upside—something like 70% to 80% of the returns of broad markets, but only about 50% to 60% of the drawdowns. And, in today’s market where valuations are fairly tight, that is particularly interesting to a lot of clients.

And, as a final point, you should actually be rooting for rates to move higher over time. It’s very contrary to how people think about fixed income in general, but, as interest rates move higher, in general that means that companies are generating a lot of earnings, [and] growth potential is very high. And, as a result, your credit risk steps down quite dramatically.

Will Smith is Director of US High Yield at AllianceBernstein (AB).

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to change over time.