Amundi, Newton Investment Management and Western Asset Management are drilling down into company balance sheets, looking at how they make their money, gauging profit margins and weighing how well they can cope with rising interest rates and slowing global growth.
And that's in addition to stretched valuations, the prospect of fewer central bank asset purchases and a new coronavirus strain the market knows little about.
"Investors will need to do more stock picking," said Gregoire Pesques, head of global credit at Amundi, Europe's largest asset manager.
"There's less overall value in the market as a whole. But it's also because specific risk is going to grow, so you’ll be more rewarded if you spend more time on name selection."
It's a shift from the past two years, where virtually all corners of credit rallied after central banks and governments stepped in to provide unprecedented support during the pandemic. But the vast stimulus unleashed to support economies following periodic lockdowns has fueled rampant inflation. And the prospect of higher interest rates will push up borrowing costs, albeit from historic lows.
"There's going to be divergence within credit, and within geographic regions," said Paul Brain, head of fixed income at Newton Investment Management. "Credit analysts are really earning their salaries now."
One area where credit may differ is capital expenditure, which is booming as firms dip into the war chests they accrued earlier in the pandemic, according to Bank of America strategists, led by Barnaby Martin.
In a research note dated Nov. 12, the strategists recommended buying the debt of companies that spend heavily in areas promising sustainable, high-quality, top line growth. Transport, tech and retail are among the sectors with the strongest year-on-year capex growth, according to their analysis.
But the same sectors are also grappling with supply-chain bottlenecks, underlining the need to be selective.
Another is deal-making, which can have mixed outcomes for bondholders, according to Western Asset Management's head of non-U.S. credit, Annabel Rudebeck. Case in point: the bonds of Telecom Italia SpA and U.K retailer Marks & Spencer Group Plc dropped last month on reports of private equity buyouts, since this can saddle companies with more debt.
Until recently, the vast pandemic-era stimulus has served as a lifeline supporting the weakest companies. An extension of that support, should the pandemic enter a dangerous new chapter, could foster another broad-based rally, rendering stock-picking less vital.
But central bankers are in a difficult position.
Even with a new virus strain spreading globally, Federal Reserve chair Jerome Powell said last week that asset purchases could end sooner than planned given ongoing inflation. And should central banks ease monetary stimulus, companies that have weathered price pressures so far may start to see their margins sag in 2022.
"Jump forward to the middle of next year, you'll have tightening of monetary conditions at a time of higher costs," Newton Investment's Brain said, adding that one of the gaps that may open up is between CCC rated bonds, the lowest rung of junk, and BB rated bonds if default rates start to creep higher.
"Credit markets may start to have a serious wobble at that point."
"Smart and short"
But backing the right companies isn't enough: investors will also need to look out for the right debt structures, said Gina Germano, head of high-yield bonds and syndicated loan investments at Hayfin Capital Management.
Inflation and central-bank tightening concerns make floating-rate instruments such as leveraged loans and collateralized loan obligations attractive, she said.
Investors can also significantly reduce duration risk by picking notes that benefit most from roll-down, the natural spread compression that occurs as bonds approach maturity, said TwentyFour Asset Management portfolio manager Pierre Beniguel. Three-to-five-year bonds will tend to offer the best gains as the short end of the curve steepens, so long as they provide enough spread to absorb anticipated rate rises.
The bottom-line is that "2021 hasn't exactly been the hardest year to be a credit analyst," said Beniguel. "Credit exposure should be smart and short in 2022."