At the start of 2020, corporate bonds were friendless. Revenues looked meager and their potential for capital growth limited. High issuance had left a glut of supply, while investors had seen their protections eroded by a new covenant-lite approach. How times have changed.
Opinions formed before the coronavirus outbreak quickly became outdated. Not only have the outlook for the economy, interest rates and businesses fundamentally changed, but asset pricing has undergone a sea change. Today, some are suggesting this is the “best buying opportunity of the century” for corporate bonds. Asset allocators – even with a multitude of cheap assets to choose from – attract capital to the sector.
Managers tend to favor their own asset class, but their enthusiasm seems real. “Bonds are the deal of the century – the last time we had this kind of opportunity was in 2009 and I think the opportunity is even better today,” says Grégoire Mivelaz, co-manager of GAM Star Credit Opportunities. “Probably the best investment grade market I’ve seen in my career,” says Ben Edwards, director of BlackRock Corporate Bond.
Why so good? Admittedly, there has been a fairly drastic widening of spreads over government bonds. While the yield on a 10-year Treasury fell below 1% (0.7% as of April 9, 2020 – Bloomberg), the average corporate bond saw its price fall (and its yield rise ) as investors worried about corporate failures.
On the face of it, this seems worrying, reflecting the pressure many companies are under, but many believe markets may have gone too far in pricing risk. Darius McDermott, Managing Director of FundCalibre, said: “Given the threat of a severe global recession, markets have priced in unprecedented levels of default, but most managers believe the numbers have been exceeded and assets bonds were oversold. They also believe that the bond market rally will pay off. »
“Bond prices have fallen to very low levels. As prices have fallen, yields have risen dramatically and, for the first time in many years, investors are being compensated for taking extra risk on corporate bonds.
The Federal Reserve and other central banks have stepped in to start buying corporate bonds, helping to support prices. Stephen Snowdon, fund manager of Artemis Corporate Bond, said: “The initial sell off was indiscriminate and turned into the worst liquidity shortage in credit markets that I have seen in my 25 years as a manager. ‘investor.
“But then the new issue market kicked off, thanks in large part to the Federal Reserve announcing that it would start buying corporate bonds. We sold riskier bonds to buy replacement bonds from better quality, and you’d think that would imply a big drop in yield – but no. The first two trades were done so cheaply that we were able to improve the quality of the fund without narrowing the credit spread too much.”
Asset allocators turned to higher quality corporate bonds rather than stock dividends. Gary Potter, co-head of multi-manager at BMO Global Asset Management, says: “We have started to adjust our portfolios to corporate debt. Obligations are contractual, companies must pay the coupon. Likewise, we don’t necessarily want to speculate that equities may rebound when the economic situation in the United States is so uncertain. At this level, 6% on corporate debt seems attractive.
Both McDermott and Potter say this is strictly an active asset manager game. There are many sectors – airlines, travel agencies, restaurant and pub chains – where the fallout from the virus is not yet clear. There will be horror stories for the unwary. This has been seen in the number of “fallen angels” – companies whose debt has been downgraded due to changing earnings prospects – that have hit the high yield market.
McDermott says active managers can weed out companies whose balance sheets are strong enough to survive the next few months, and those facing extreme hardship and possibly bankruptcy. Corporate bond indices, on the other hand, will tend to have the highest weighting in the most indebted companies, which may be the most vulnerable in this environment.
Potter said, “We’re not buying the index. We buy from specialized managers who pay particular attention to quality. There has been a general sell-off and it has been possible to get high-quality corporate debt at a lower cost, but some companies will go to the wall.