The initial phase of the economic restart has been quicker than expected, evidenced by the recent IMF’s upgrade to its global growth outlook. Yes, we have seen a rise in Covid-19 infections, but fatalities and hospitalizations have abated and a severe second wave seems less of a concern versus a few months ago. Nevertheless, our economy is not out of the woods and faces significant challenges in the near term. So far, long-term permanent damage appears limited but we are not credulous enough to believe high-touch sectors will not be significantly affected. Restaurants, bars, movie theaters, etc. are continuing to work around a limited capacity for customers with risking overhead. Still, our investment perspective remains pro-risk as we consider the economic restart just beginning and gaining momentum.
A particular circumstance that may be taking shape is private credit. Many companies, large and small, may need private credit to restructure post-Covid. Not only is private credit a valid solution, they can serve as opportunities for portfolio diversification. In fact, we put these in the same class as higher-yielding credit and see this as a continued investment opportunity amid low rates.
Supportive fiscal and monetary policies to cushion the pandemic’s blow have helped companies raise capital and lower borrowing costs. Yet, not all borrowers have benefited evenly. Large companies have borrowed with ease on the public market; smaller companies have lacked the same access. The interest rate gap between U.S. middle market and large corporate loans has widened this year, according to S&P’s Leveraged Commentary & Data (LCD). Many companies will likely have to evolve their business models as the pandemic accelerates long-term structural trends such as digitalization. We see this creating a wave of restructurings – and room for private credit to cater to smaller and lower-credit quality issuers. The current environment presents a significant opportunity for the private markets to fund post-Covid restructuring for companies of all sizes, but primarily small to medium size firms.
The looming question, however, is how will Covid-19 effect the economy as we work our way to year-end and the so-called second wave? There are growing concerns that the U.S. recovery may lose steam without further fiscal stimulus. Negotiations on a pre-election fiscal package continue in fits and starts, but the window for a pre-election deal is rapidly narrowing. From our perspective, we hesitate to give credence to a resurgence of Covid-19 at the same level seen in the spring. The daily rate of new infections, according to medical experts, are likely a fraction of peaks seen in early summer. Masks are being worn with greater consistency and consumers are not letting a simple face covering dissuade their decision to live life. Moreover, the economic restart has come to fruition much quicker than expected. However, the hardest part is yet to come as it relates to the path to a full recovery. The trajectory is in the right direction, but recovery will be uneven with certain pockets of the economy doing better than others. Overall, the economic engine is running at a pretty solid pace. Our focus at this point is the U.S. election.
Many of you continue asking “how should we be invested headed into the election?” or “should we go to cash?” Our pro-risk stance is not to be confused with an attitude of insouciance. Rather, we are cognizant of U.S. equity vulnerabilities as fiscal stimulus is fading and a new round of stimulus appears unlikely as dissonance grows among political factions. Our preference is sustainable assets and diversification (multi-country) on a strategic basis. In our view, building a resilient portfolio requires more than simply diversifying – discipline and strict rules must be applied in order to avoid the emotional biases that rob individual investors’ consistent performance.