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- On Fixed Income
- Smoothing the Ride for Credit Allocations
- Dynamic Credit Fund offers a flexible, differentiated approach.
- 2023-05-01 11:10
- Saurabh Sud, CFA, Portfolio Manager, Dynamic Credit Fund
- Key Insights
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- The Dynamic Credit Fund posted a nearly flat return in 2022, demonstrating the value of its approach in a historically difficult year for credit markets.
- The fund is well suited for those who want to take advantage of credit opportunities while also seeking a “smoother ride.”
- The fund focuses on credit selection and sector rotation to generate alpha, coupled with active duration and credit beta management.
The Dynamic Credit Fund seeks to offer investors a “smoother ride” in credit investing by finding diverse alpha1 sources in a variety of market environments. The fund focuses on credit selection and sector rotation across the credit spectrum—high yield, investment grade, emerging markets, securitized, distressed, municipals, convertibles, and bank loans—of the global multi‑asset credit (MAC) universe.
The fund harnesses expertise across T. Rowe Price’s global multi-sector research platform to deliver an actively managed, flexible portfolio with a long2 bias. Coupled with this long bias, which is expected to deliver 80% of the fund’s returns, we employ active credit shorting3 and duration4 management in looking to add further alpha and dampen volatility. Our strong emphasis on finding credit dislocations, our total return perspective, and our goal of creating a differentiated portfolio are embedded in the design and the process of the fund.
Key Source of Differentiated Returns
In addition to the fund’s goal of delivering alpha across the broad credit market, we also strive to limit undue credit beta and duration risk. We believe that our approach to portfolio construction makes the fund a compelling and consistent credit allocation, and its differentiated returns also enable it to complement other credit allocations. The fund’s lower credit beta profile should allow it to hold up well in environments where credit spreads5 are widening, while its lower duration profile should be a positive in rising interest rate environments.
The fund’s repeatable process relies heavily on our global research platform of more than 300 people, who collaborate across investment strategies, asset classes, and geographies. Our team of credit analysts integrates proprietary environmental, social, and governance (ESG) factors as appropriate into the analysis. The table below provides examples of typical types of positions:
| Sector | Industry | Long/Short | Description |
|---|---|---|---|
| High Yield | Automotive | Long | U.S.-based electric vehicle manufacturer positioned to compete with market leader Tesla. Bonds were secured by assets with a floating rate coupon that provided attractive risk/reward characteristics. |
| Investment-Grade Corporate | Utility | Long | European energy company that was remaking itself in 2022 to focus on green energy technology and was proving itself as a leader in the clean energy transition in Europe. |
| Convertible | Tech/Media/Telecom | Long | A communications and media company, where the convertible bonds6 offered exposure to an improving credit along with an attractive yield and the potential for exposure to a rising stock price. |
| High Yield | Health Care | Short | A U.S. health care company that was de-consolidating its businesses, leaving one entity over-leveraged and with fundamental business challenges. As a result, we anticipated that its credit spread would widen materially and shorted the credit through derivatives. |
As of March 2023. Subject to change.
Credit Exposure: Creating a Better Way
(Fig. 1) Fund strives for more flexible, alpha-oriented outcomes
Source: T. Rowe Price.
Green icons represent expected outperformance versus credit beta; red icon represents expected underperformance. For illustrative purposes only.
The expected performance for Dynamic Credit is relative to alternative credit indices such as investment grade corporates, high yield corporates, or emerging market bonds. Market environments and expected performance are based on the general strategy structure, but are not based on actual performance, nor intended as forward-looking performance projections. As with any investment, performance may vary and is subject to potential loss. Actual performance may differ significantly.
Three Primary Credit Evaluation Factors
When collaborating with our credit sector experts and evaluating individual credits for potential portfolio inclusion as either long or short positions, we ask three key questions:
- Is there a catalyst that could cause the credit to outperform? Depending on the type of credit, this could be a range of factors, such as a potential credit rating upgrade or downgrade for a corporate credit. For consumer‑dependent credit like an asset-backed security (ABS) backed by auto loans, it could be an upturn in consumer payment trends.
- Is the position positively or negatively correlated7 with the performance of existing portfolio holdings? A meaningful negative correlation could indicate that the new position can provide diversification benefits by gaining when other exposures lose value.
- What is the asymmetry of the return profile? Essentially, will the price benefit more from a positive development than it suffers from a negative outcome—or vice versa? This can affect how a holding would fit into the fund’s overall positioning in terms of sizing, diversification, and potential alpha generation.
Performing as Expected
(Fig. 2) Dynamic Credit Fund held up in volatile 2022
Performance data quoted represents past performance and is not a reliable indicator of future performance. Investment return and principal value will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data quoted. The fund’s total return figures reflect the reinvestment of dividends and capital gains, if any. The fund’s gross expense ratio is 1.25% as of the most recent prospectus.
As of March 31, 2023. Figures calculated in U.S. Dollars. All percentages for time periods greater than one year are annualized.
Sources: T. Rowe Price and Bloomberg Finance L.P.
*January 10, 2019.
† Indexes shown represent beta credit returns and are benchmarks used by ETFs: High Yield Bond, Emerging Market Bond, US Investment Grade Index and Bloomberg US Aggregate Bond Index, respectively. The ETF benchmarks are shown for illustrative purposes to demonstrate how each of the different sectors performed for the period when looking at passive indexes (peer proxies).
‡ MAC Custom index is represented by 1/3 Bloomberg US Corporate High Yield Bond Index, 1/3 S&P/LSTA Leverage Loan Index and 1/3 Bloomberg Emerging Markets Hard Currency Aggregate Index. The MAC benchmark is a TRP proprietary benchmark that is used to compare the MAC sectors against a comparable benchmark. Please see Additional Disclosures page for information about this S&P information and this Bloomberg information.
§ Information has been obtained from sources believed to be reliable but J.P. Morgan does not warrant its completeness or accuracy. The index is used with permission. The Index may not be copied, used, or distributed without J.P. Morgan’s prior written approval. Copyright © 2023, J.P. Morgan Chase & Co. All rights reserved.
Effective 1 May 2021, the benchmark for the Dynamic Credit Fund changed to the ICE BofAML US 3-Month Treasury Bill Index. Prior to this change, the benchmark was the 3 Month Libor in USD.
In addition to addressing these three factors, our investment process tries to ensure that we are getting paid for each position’s embedded credit beta,8 volatility, and liquidity. Our dynamic, flexible, and alpha-oriented approach enabled the fund to deliver differentiated performance during the challenging market in 2022, when traditional credit sectors suffered amid rapidly rising rates.
Approach Well Suited for Unsettled Credit Environment
The fund’s alpha-seeking but risk‑aware approach is well suited for a range of market conditions, but it may be even more valuable in the current unsettled credit environment. We believe that our fundamental credit analysis process that generates forward-looking insights from a global research platform with broad sector expertise can help the fund identify and capitalize on inefficiencies ahead of the market.
We have recently observed that banks are tightening their lending standards, which typically precedes the end of a credit cycle and rising defaults by two to three quarters. This changing environment may produce opportunities across the range of credit markets.
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FOR INVESTMENT PROFESSIONALS ONLY. NOT FOR FURTHER DISTRIBUTION.
1 Alpha is the excess return of an investment relative to its benchmark.
2 Long positions benefit from credit improvement.
3 Short positions benefit from credit deterioration.
4 Duration measures a bond’s sensitivity to changes in interest rates.
5 Credit spreads measure the additional yield that investors demand for holding a bond with credit risk over a similar‑maturity, high‑quality government security.
6 Holders of convertible bonds can convert the debt into equity if the stock trades at or above a predetermined price.
7 Correlation measures how one asset class, style, or individual group may be related to another. A perfect positive correlation means that the correlation coefficient is exactly 1. This implies that as 1 security moves, either up or down, the other security moves in lockstep in the same direction. A perfect negative correlation means that 2 assets move in opposite directions, while a zero correlation implies no relationship at all.
8 Beta measures the volatility, or risk, of an investment relative to the risk of the broad market.
Additional Disclosures
“Bloomberg®”, Bloomberg U.S. Aggregate Index, Bloomberg US Corporate High Yield Bond Index , and Bloomberg Emerging Markets Hard Currency Aggregate Index are service marks of Bloomberg Finance L.P. and its affiliates, including Bloomberg Index Services Limited (“BISL”), the administrator of the index (collectively, “Bloomberg”) and have been licensed for use for certain purposes by T. Rowe Price. Bloomberg is not affiliated with T. Rowe Price, and Bloomberg does not approve, endorse, review, or recommend the T. Rowe Price Dynamic Credit Fund. Bloomberg does not guarantee the timeliness, accurateness, or completeness of any data or information relating to the T. Rowe Price Dynamic Credit Fund.
Copyright © 2023, S&P Global Market Intelligence (and its affiliates, as applicable). Reproduction of any information, data or material, including ratings (“Content”) in any form is prohibited except with the prior written permission of the relevant party. Such party, its affiliates and suppliers (“Content Providers”) do not guarantee the accuracy, adequacy, completeness, timeliness or availability of any Content and are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, or for the results obtained from the use of such Content. In no event shall Content Providers be liable for any damages, costs, expenses, legal fees, or losses (including lost income or lost profit and opportunity costs) in connection with any use of the Content. A reference to a particular investment or security, a rating or any observation concerning an investment that is part of the Content is not a recommendation to buy, sell or hold such investment or security, does not address the suitability of an investment or security and should not be relied on as investment advice. Credit ratings are statements of opinions and are not statements of fact.
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Important Information
This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.
The views contained herein are those of the authors as of April 2023 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.
This information is not intended to reflect a current or past recommendation concerning investments, investment strategies, or account types, advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Please consider your own circumstances before making an investment decision.
Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy.
Investments in high-yield bonds involve greater risk of price volatility, illiquidity, and default than higher-rated debt securities. Derivatives may be more volatile than other types of investments because they are generally more sensitive to changes in market or economic conditions. Short sales are speculative transactions with potentially unlimited losses; use of leverage can magnify the effect of losses.
Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. All charts and tables are shown for illustrative purposes only.
202304-2866842
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Alpha is the excess return of an investment relative to its benchmark.
Duration measures a bond’s sensitivity to changes in interest rates.
Beta measures the volatility, or risk, of an investment relative to the risk of the broad market.
-
Important Information
This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.
The views contained herein are those of the authors as of April 2023 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.
This information is not intended to reflect a current or past recommendation concerning investments, investment strategies, or account types, advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Please consider your own circumstances before making an investment decision.
Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy.
Investments in high-yield bonds involve greater risk of price volatility, illiquidity, and default than higher-rated debt securities. Derivatives may be more volatile than other types of investments because they are generally more sensitive to changes in market or economic conditions. Short sales are speculative transactions with potentially unlimited losses; use of leverage can magnify the effect of losses.
Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. All charts and tables are shown for illustrative purposes only.
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