Greg Peters
As debates around credit valuations, private market risks and the durability of higher interest rates intensify, investors are reassessing how to position fixed-income portfolios for a more uncertain regime.
Greg Peters, co-CIO of PGIM Credit, discussed with CIO the opportunities in fixed income allocators should be looking at and the firms outlook for credit.
CIO: Are credit markets pricing in too benign an outlook, given geopolitical risk, sticky inflation and refinancing pressures?
PETERS: Yes, markets are pricing in a benign outlook, but they are also reflecting a backdrop of positive fundamentals. So in that sense, tight spreads are not entirely disconnected from the underlying picture. Spreads are tight for a reason.
At the same time, we are investing in an environment with very thick tail [risk] and with asymmetrical downside. Geopolitical risks and inflation shocks, all else being equal, will create refinancing pressures. However, I think investors sometimes make too much of the so-called maturity wall. I have yet to see maturity walls, in and of themselves, create major issues.
The more important point for me is that credit stability does not necessarily warrant aggressive investment. In fact, the best time to invest in credit is usually when conditions are less than rosy and the distribution of outcomes is tilted more in your favor. For me, the credit markets are more of a valuation issue than a concern about credit itself.
CIO: What would convince you that the market is underestimating the risk of structurally higher long-term interest rates?
Peters: I think we are in the middle of a secular shift toward a higher-rate environment. One of the challenges is that many investors still exhibit post-[Global Financial Crisis] muscle memory, where any hiccup or scare was ultimately met with a policy response that lowered rates. I do not think that simple framework applies in a world shaped by repeated inflation shocks. To me, that changes the calculus. We are in a regime where rates are likely to remain higher than what investors became accustomed to over the previous decade, and I do not think the market has fully appreciated that yet. Ironically, however, this backdrop is healthy for fixed income. One of the biggest challenges for bond investors during the low-rate era was that yields were simply too low to generate meaningful income. Higher yields restore balance to the asset class and make fixed income more compelling.
When I think about what could keep yields structurally elevated, there are a couple of key drivers. First, forward inflation expectations still look too low to me, given that inflation has run above target for an extended period. Over time, I would expect these forward expectations to adjust higher. Second, we are seeing an enormous amount of debt supply globally, whether through sovereign issuance or capital-intensive investment themes like digital infrastructure. The sheer quantum of supply creates a crowding-out effect and can put additional upward pressure on yields.
CIO: If we do get more volatility, which parts of credit look most vulnerable first—lower-quality investment grade, high-yield loans or something else?
PETERS: If volatility picks up, I still think the beta dynamics will hold. Spread markets are generally efficient, and tighter spreads are usually tight for a reason. All else equal, they often reflect lower underlying risk. If the backdrop becomes more volatile or growth concerns intensify, I think the pressure moves lower down the quality spectrum. For me, leveraged loans remain the area of greatest vulnerability. That is where, in the public markets, you have seen the most risk accumulate in the system, with more levered capital structures than we have typically seen historically.
By contrast, the high-yield bond market is in excellent relative fundamental shape, and a lot of the risk has migrated elsewhere.
On lower-quality investment-grade corporates, our view is a bit more nuanced. We tend to like that part of the market because large investment-grade issuers are often highly motivated to defend their rating and, in our view, that “back-against-the-wall” mentality is often underappreciated by the market.
CIO: With some allocators questioning private credit valuations and liquidity assumptions, do public fixed-income markets look more attractive on a risk-adjusted basis?
PETERS: It depends on how you define risk, because that is really at the center of the debate. Many investors in private and illiquid assets do not think about risk primarily through the lens of day-to-day volatility. They have long-dated liabilities, so short-term price movements are often less relevant, which is an important distinction.
At the same time, I do think there has been a tendency in parts of the market to be a little too casual about properly risk-adjusting returns in private assets, almost as if the absence of daily marks means the analysis does not need to be done as rigorously.
More broadly, though, I see opportunities in both public and private markets. What is happening in public BDCs right now, along with some of the negative attention on private credit—warranted in some cases—has created opportunities as well.
However, despite tight top-line index spreads, this is one of the most compelling environments for credit selection that I have seen in my career. It is going to be a more dispersed, credit-driven market. Themes like AI adoption will create clearer winners and losers across sectors and issuers.
For a long time, credit moved largely as a beta trade driven by central bank policy, but I do not think this will be the case moving forward. It is clear to me that idiosyncratic credit risk is going to assert itself, and individual security selection and fundamental credit work will matter much more than simply allocating passively or indiscriminately to the sector or asset class.
CIO: Do you think institutional investors have over-allocated to illiquid credit strategies in search of yield?
PETERS: Yes, I do. That is largely a consequence of the ultra-low-rate environment that prevailed for so long. Institutional investors were operating in a world where traditional fixed income offered very little income, so they were pushed toward taking more risk—more complexity and illiquidity—in search of return. The result is that many allocators now look out of balance. Part of that is simply mechanical. Public fixed-income markets repriced sharply higher as yields moved up, while private assets did not adjust as quickly, which left many investors naturally more heavily allocated to private strategies than they intended.
On top of that, existing private equity dynamics have created additional challenges. Many institutions expected capital to come back from private equity on a certain timeline, but exit activity has been much slower than anticipated. That means the cash has not been returned when expected, and in many instances, allocators have had to sell out of more liquid strategies to meet ongoing obligations, which has exacerbated the imbalance.
So, the short answer is yes. The longer answer is that the over-allocation is less about strategy preference today and more about how years of low yields, slower private exits and uneven repricing have all compounded into the current position.
