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The era of facemasks and sanitisers may be behind us, but Covid-19’s impact on financial markets is only beginning to manifest. This week’s Chart Room takes a data-driven look at the factors fuelling performance in global credit markets. 

A comparative analysis of data covering the past eight years based on a multifactor credit model developed by Fidelity International shows that there has been a pronounced shift in credit markets from sentiment factors to a greater focus on fundamentals and valuations. The model categorises approximately 200 signals per issuer into three factor groups: fundamental, sentiment, and valuation, then analyses the performance of these factor groups over time and across markets, as well as at the issuer level. 

The results show how sentiment factors have proven to be much less effective since March 2020, where their risk-adjusted performance has been close to flat in investment grade and has been negative in high yield bond markets. Fundamental and valuation factors have shown positive risk-adjusted returns in both periods.

Sentiment was a strong source of returns before the pandemic. But in an environment where corporate profits are under pressure, investors have tended to allocate towards companies that can maintain growth and earnings resilience, and can continue to comfortably service their debt. Investors would also anticipate greater divergence between winners and losers in a ‘hard landing’ scenario for the world economy. Valuation’s outsized importance illustrates the demand for more downside protection.

Yet it would be risky to ignore sentiment altogether. While the prospects for the global economy are looking gloomy right now, data in most developed markets has remained relatively robust. An upside ‘soft landing’ surprise, or even a shallow recession, could swing the pendulum again in sentiment’s favour. One benefit of a systematic, multifactor approach is that it is designed to support diversification across factors and deliver performance in different market environments. It’s a useful reminder for credit investors not to become overly attached to a particular style or factor.

Peter May

Peter May

Quantative Analyst

Konul Mustafayeva

Konul Mustafayeva

Stuart Rumble

Stuart Rumble

Investment Director