The Long and Short
Banks and REITs poised to outperform
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Banks and REITs look poised to outperform other investment grade credits if spreads continue to tighten. These sectors have generally lagged the investment grade index since at least mid-2021. But in the recent tightening in spreads—more than 40 bp in OAS on the index since mid-October— banks particularly along with REITs have recovered more than others due in part to limited supply as well as the rapid recovery in higher beta credits such as Credit Suisse. This trend should continue if spreads stay on their current glide path and investment grade credit continues to be well bid.
Exhibit 1. IG OAS move by sector since the post-pandemic tights (6/30/21)
Source: Amherst Pierpont, Bloomberg/Barclays IG Index
Banks and REITs have turned in relatively weak performances since investment grade credit hits its tightest levels in mid-2021 (Exhibit 2, 3). This shows up in both OAS and credit returns. Spreads since mid-2021 have widened by 65 bp for banks and 71 bp for REITs. The only segment that saw more volatility was the smaller finance companies in the index. Looking at excess return, which captures performance net of equivalent Treasury debt, banking (-1.56%) and REITs (-2.09%) fell among the bottom sectors in the entire investment grade index.
Exhibit 2. Excess returns by sector since the post-pandemic tights (6/30/21)
Source: Amherst Pierpont, Bloomberg/Barclays IG Index
In mid-2021, banking traded tighter than any other sector at a level wrapped around 65 OAS and a duration of about 5.8 years (Exhibit 3). REITs stood at a level of about 82 OAS, which was relatively in-line with some of the lower-duration segments of the index such as consumer non-cyclical (77), capital goods (77), and insurance (85).
Exhibit 3. Sector-by-sector OAS vs duration at the post-pandemic tights (6/30/21)
Note: the graphic demonstrates where each sector OAS was relative to duration at the time that the index achieved its tightest level since mid-2021. The size of the spheres represents each sectors’ relative market value in the index.
Source: Amherst Pierpont, Bloomberg/Barclays IG Index, size indicates the relative market value of each sector within the index
Those dynamics have changed over the past roughly year and a half as the two sectors, banking and REITs, have vastly underperformed other segments over that period (Exhibit 4). Banking OAS now sits at roughly 130, above the index average of 123. This is a substantial change from where it sat relative to other sectors when the index was at the local tights. Likewise, REITs are now at an OAS of 153, making them the second widest trading segment in the index only to the small, higher-risk finance companies bucket. As spreads move tighter, these sectors should continue to revert closer to their relative placements along the OAS and duration curve.
Exhibit 4. Sector-by-sector OAS vs duration as of this week (1/18/23)
Source: Amherst Pierpont, Bloomberg/Barclays IG Index, size indicates the relative market value of each sector within the index
Obviously, there are critical fundamental and credit as well as supply and demand dynamics that have been accounting for the changes these sectors have undergone within the index over the past year and a half. In the case of the banking sector, higher beta Yankee credits such as Credit Suisse have been weighing heavily on overall sector performance over the past several months. Meanwhile, REITs have struggled as fundamental perceptions about broad sector’s operating outlook have caused a shortage of demand for paper within the segment. Nevertheless, as the overall trajectory of spreads continues to improve, these sectors look poised to outpace the broader index and see their relative placement along the OAS and duration spectrum revert back to more historical norms if the overall index moves tighter.
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