Pilar Gomez-Bravo of MFS Investment Management is using a ‘three-body problem’ framework to describe the increasingly entangled risks facing fixed income markets, warning that AI, private credit and geopolitics are now moving markets simultaneously rather than sequentially.
Speaking with Investor Daily, the co-CIO of fixed income said investors are navigating multiple structural forces interacting in real time, complicating traditional risk assessment.
First is AI and its financing implications, including a surge in capex, a shift in funding from equity to debt, and knock-on effects for credit markets. She warned this could reshape risk in investment grade credit and pressure certain software and tech business models.
“The impact of AI capex, and the evolution of that AI business model with regards to supply of bonds, certainly now having to be financed by us and not shareholders. What does that mean for credit risk and supply in the markets? What does it mean with regards to software and other businesses that might have their business models challenged? And how much of that type of debt is in our markets that we should be worried about?,” she told Investor Daily.
Second, Gomez-Bravo said, is private credit and its growing interconnectedness with leveraged loans and high yield markets. While often viewed as separate, she flagged potential spillovers and questioned whether stress in private credit could transmit into broader credit conditions, particularly as refinancing cycles tighten.
“What are the interlinkages between private credit, ideal and leveraged loans? It’s easy for us to sit here saying, ‘Oh, it’s nothing to do with us. It’s private credit investors who are going to suffer losses.’ But – are there any systemic ramifications? Is it going to impact the high yield bond market?”
Gomez-Bravo said this dynamic is increasingly intertwined with the AI story.
“The more the AI story builds up, the more challenging it is going to be on what exposure some of these private credit funds have, and how easy is it going to be to refinance? Whether or not those credit conditions are going to be tightening, as there’s more scrutiny on who’s lending to these private credit entities.”
Geopolitics is the third “body”, which Gomez-Bravo described as a persistent tail risk capable of suddenly repricing markets. She pointed to energy shocks and geopolitical flashpoints as catalysts that can feed through to inflation, monetary policy and financing conditions.
“We started thinking about positioning our portfolios. Not so much, because we thought that Iran was going to get bombed, but we started getting worried when the White House was going against Greenland, and we thought ‘this could be a significant risk for Europe’ at the time,” she said.
That factor has prompted the co-CIO to reassess portfolio risk management.
“When you start thinking about geopolitics … there’s always a war somewhere, right? It always is an issue, but it’s one of those things that doesn’t get priced until it does. So you at least have to have awareness of it as a tail risk that could impact your position in the market.”
Gomez-Bravo said markets typically contend with one major issue at a time.
“We have to deal with the three of them together and try to understand which one is leading which – and whether one takes more prominence or not, whether one is more immediate as a risk, and the other one might be slower moving…”
As for which of the three bodies is at the front of her mind, she pointed to the Middle East and sees inflation as the key threat over the next 6-12 months. Over the longer term, AI looms on a three to five-year timeline.
“The Middle Eastern crisis is leading at the moment, mostly because of inflation. We all have PTSD from 2022 and I think the first memory is, ‘here we go again’,” she said. “That’s the one that is more dominant, because that’s the one that can determine monetary policy reactions … whether the RBA is going to hike one time – or they’re going to hike three times. It’s the same across the world – so that is a more immediate risk.”
Further out, the focus shifts to the credit cycle.
“Are we going to go into recession? That’s again, where maybe some of the private credit elements will be reflected in the credit cycle. That’s when the private credit issues come to the forefront,” she said.
Despite the backdrop, MFS Investment Management still sees opportunities for active managers.
“I think that’s what excites active managers, you’re always scrambling around trying to find any sort of basis point that you can eke out for performance. There’s not a lot of dislocation at the top down level,” she said.
“We are starting to see opportunities within the sectors. For example, we’re starting to look at whether or not the debt of the business development companies (BDC) has.. all BDCs have underperformed because of the private credit story. We’re starting to find opportunities within the ones that we like.”