Many factors have contributed to a proliferation of debt at the sovereign level, including the coronavirus pandemic and central bankers subsequent fight against inflation.
“A lot of themes we’re talking about have led to some scarcity, supply chain fragility leading to that inflationary impulse in tandem with continued fiscal largess,” said Renato Latini, portfolio manager and senior research analyst at Brandywine Global, during a session made possible by Franklin Templeton Investments at the Canadian Investment Review’s 2025 Global Investment Conference.
Across credit asset classes, there are different risk-reward metrics, which facilitate the need for a more active approach to managing through these credit cycles, he said. For example, following the 2008/09 financial crisis, banks’ limited ability to underwrite certain credits led to an increase in syndicated loans.
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“Regulations have limited [underwriting] as well and so private debt came in and served an important function to disintermediate that underwriting.”
In the high yield space, particularly post-pandemic, management teams have been locking down assets and using those as collateral or to help securitize against a bond issue, said Latini. “High yield has been fairly well behaved . . . and leveraged loans have been leading the charge in this default cycle, largely as a function of underwriting more questionable credits.”
With the continued volatility of inflationary regime changes and more persistent budget deficits, quick responses from fiscal and monetary policymakers can “paper over a lot of things by design,” he said, noting the ability for developed market central banks to rapidly cut rates may be more limited in a constrained world with higher inflation.
“And then the fiscal thrust you’re starting to see from developed market policy makers may also be more constrained as the interest cost as a percentage of the deficit continues to rise.”
A multi-asset credit approach can add value, said Latini, because it allows investors to stay nimble and be able to allocate between these asset classes at different times. “You don’t need to have a static allocation to credit through the cycle particularly in the liquid markets like high yield debt, syndicated leverage loans [and] even corporate [emerging market] debt that’s more on the syndicated side, less on the private side.”
Moreover, he said it’s important to focus on leveraging a multi-asset credit approach and potentially credit as core, particularly as it pertains to developed markets sovereign rates, which are typically the bastion of stability during market turmoil. “We think the ability to shift across asset classes, like credit right now, is instrumental to generating strong total returns.”
Management teams need to be laser-focused on balance sheets in this higher yield world, noted Latini, and be proactive in terms of financing activity, particularly as policy makers are increasingly constrained in an uncertain geopolitical environment.
“I think the thread that’s woven through all of this is a lot of uncertainty. But what is certain is that management teams have to focus on balance sheet in a higher rate environment. And we’ve found ways through COVID to do that. Securitizations, willingness to refinance — that yield to outcome — [and], even when you’re looking at a potentially higher coupon on your debt, taking advantage of cap markets when they are open.”
Read more coverage of the 2025 Global Investment Conference.