Pierre Verlé, Head of Credit Carmignac

Pierre Verlé is our Fund Manager of the Month. He is the head of credit at Carmignac with over 16 years of experience in the industry. Piere joined Carmignac in 2013 as a credit analyst and has held his current position since 2015. Pierre holds an Engineer degree from Ecole Polytechnique and has a Master's degree in Finance from HEC. He is also a CFA Charter holder (2006) and a CAIA Charter holder (2012).

Could you give us an overview of the bond market today and where you think it’s heading over the next few months?

Credit markets like everything else in the world have been disrupted by the COVID-19 crisis and the measures taken to fight the virus. I think there have been three main factors impacting credit markets recently and we need to analyze them for context. One was the risk of a liquidity crunch. This was the biggest factor in pricing around the 19th of March. The fear of massive reductions in liquidity seemed to move the market downward. That fear was short lived because the lack of liquidity was immediately followed by massive interventions by governments and central banks world wide. And the credit markets did not degrade due to liquidity issues.

Yet credit markets were still left with two major uncertainties. Firstly on the macro side, everyone wanted to know what the total impact was going to be from the lockdowns imposed on the economy.  Moreover, how long would lockdowns be imposed and how would restrictions ease.  Interestingly the recovery in the credit market was driven mostly by liquid instruments and macro investors finding value in spreads vs. equities rather than bottom fishers buying idiosyncratic situations. Thus once liquidity was figured out the market was on its way to normalizing again. 

The last issue that impacted the market (which is still outstanding) is the uncertainty on the micro-level. It’s extremely difficult to assess the damage done by weeks or months of shutdowns. At the current moment we don't know what costs these businesses have been able to cut or defer. And we don't know the overall impact on an individual firm's balance sheet. This issue is the one that will persist with us until later in the summer, because bottom fishers and those who analyze financial statements will need to wait for the reports of the second quarter to move forward effectively. 

I think that within three months we will have much more data and by virtue more visibility on who’s been impacted and to what magnitude the crisis has affected them.

So out of these three issues, the liquidity has been addressed. I think the macro uncertainties have not been addressed at all but the market is used to operating without having total information. So the biggest thing moving forward over the next three months and moving forward is this additional information coming out. As more information comes available we will have more participants in the market and the “bottom fishers” will start to become more involved. 

Do you anticipate additional increases in quantitative easing and more robust central bank measures pushing money into relatively stable corporate debt? 

I’m not sure if we will see additional flows of capital. And I’m not certain if I would like to see more money in the asset class due to spreads tightening. We know that markets have been driven by fear, and they are always driven by fear or greed. The same fear we have seen over the past couple of months presented itself in late 2007 and in any correction for that matter. 

2019 Was a real bull market for credit. However, you still had a lot of aversion to idiosyncratic risks. Many were focusing on what they perceived as safe and shying away from what they saw as risky. If you compare last year’s credit bull market with other rallies you will notice this as a pretty clear differentiator. People came in with a bit more trepidation this time around. 

In 2006 for example (Another booming market for credit) you saw toxic bonds trading with very tight spreads. Everyone was driven by greed and just wanted to beat the competition. Last year people were scared of defaults but had to be invested for lack of a better alternative because of the financial repression. 

I think this time around, the biggest excesses were priced in.

What's the advantage of being in bonds during tough times?

The main advantage of credit versus other asset classes is that you buy on market sentiment (a market level, like for other asset classes), but provided you have a medium-term horizon, you make your return on a contract (coupons and repayment), not a change in market sentiment. Also, if you’re comfortable with a reasonably pessimistic scenario that doesn’t lead to a default you can invest and make a strong return. It’s more difficult to invest in equities if you don’t have an optimistic outlook.

What are some major shakeups you anticipate in the bond market due to COVID and increased market volatility?

I think we’ll rising dispersion, as results for the second quarters are released, allowing investors to distinguish the relative winners from the losers amongst issuers.

There has been fundamental risk in the bond market for some time. At the beginning of the year, half of the investment-grade market was rated BBB, whereas in mid-2007 it was a fifth. On top of that, as rating agencies had been particularly complacent, giving them the benefit of the doubt on synergies and cost-cutting, a large portion of those BBB issuers had actually BB credit metrics. This risk had been flagged for years, but the COVID-19 situation has brought a lot of it to the forefront. 

The rating agencies have started the fastest downgrading process we have seen. And this will continue moving forward. We all knew that the rating agencies were being too lax and we anticipated a market correction at some point. It seems that COVID has hastened this process considerably. 

And this increased downgrading process will obviously have profound impacts on the bond markets. In a normal cycle, credit ratings lag behind the cycle and credit spreads. However, this time, given the nature of the crisis, downgrades happen much faster. 

The other thing of note is the massive amount of issues coming in the next few weeks. Notably, companies are raising massive sums of money to combat the massive cash burn that lockdowns and global slowdowns have brought about. These companies aren’t really borrowing money to refinance debt and a lot of them have been cautious, raising more money than they will actually burn. As economies reopen faster than their cautious scenarios, they will find them sitting on too much cash they will use to repay maturing bonds without issuing new debt. 

This interview will be shown in its entirety in the coming days on RankiaPro's website. Pierre gave us great insight into the current state of the bond market. Check back for additional info.