Monica Erickson, DoubleLine Capital Investment Grade Corporate Bond Portfolio Manager, assesses the state of the corporate bond market and its areas of weakness and profitability for investors.
BRIAN SOZZI: Okay, let’s get back to inflation and interest rates here. The bond market has come to know only a land of low interest rates. This rings especially true for the corporate bond market. Falling interest rates have allowed companies to raise significant sums to fund capital spending, share buybacks and dividends.
But what happens to that cash faucet when rates start to rise in the years to come? Monica Erickson is Portfolio Manager and Head of Investment Grade Corporate Bonds at DoubleLine Capital and is joining us this Friday morning. What’s going on, Monique? We are heading to a country where interest rates are potentially higher. What does this mean for corporate bonds?
MONICA ERICKSON: Well, especially in the investment grade corporate market, one of the things we’ve been talking about at DoubleLine for a while is simply the amount of interest rate risk that the corporate grade market presents. The duration of the asset class, i.e. its sensitivity to interest rates, has increased significantly over time and now stands at around 8.5 years.
This therefore means that for every 1% change in interest rates, the dollar price of the asset class will change by around 8 and 1/2%. It therefore has a very high exposure to any type of movement in interest rates. And I think with what you talked about on your show, with – and everyone talks about it – with the worry about inflation and still very low interest rates, I think the risk is at stake. rise. And therefore, the risk is on the downside on investment grade companies.
BRIAN SOZZI: How to play this potential increase in volatility?
MONICA ERICKSON: Well I think you must have an active bond manager. And I would advise you to keep your duration low at this point. All the yields are still very low. If inflation goes up, I think at some point we will get higher rates and that will trickle down to the returns of the asset class. So the way to protect yourself against this would be to focus on floating rate securities, fixed income assets that would benefit from higher rates.
JULIE HYMAN: Monica, it’s Julie here. Now I know you are in the investment quality space. But I have to ask myself, as rates go up, what kind of vulnerabilities are we going to see exposed in the corporate bond market and if that means defaults on the lower end or downgrades even in the investment grade? Is that what we’re going to see, or are companies strong enough now that even with rising rates there won’t be a huge amount of it?
MONICA ERICKSON: Yes, I don’t think that’s the problem with the investment grade market or the high yield market. I mean, the investment grade market, actually, in terms of fundamentals, in terms of leverage, and at your point, in terms of their ability to service their debt and refinance their debt, is incredibly Well. Servicing what we – the cash flow available right now for debt servicing is at 11 times. So, EBITDA at interest, which is a measure we’re looking at, is 11 times. It would therefore take a lot of price increases to reduce the health of businesses.
Really, the concern is more on the investor side. And with those super low rates, if you have higher rates, your returns are going to be impacted. But from a fundamental credit standpoint, I think businesses are in very good shape. The payoffs have grown incredibly strong. Businesses are now above pre-COVID levels in terms of leverage and interest coverage. So it’s really more – the concern is more from an investor’s perspective and what happens to your portfolio when interest rates rise.
EMILY MCCORMICK: And Monica, this is Emily. Taking a step back for a moment, can you also explain to our viewers why someone might want to invest in investment grade corporate bonds or an index that tracks them, as opposed to the actual stocks of some of those companies that are IG evaluated?
MONICA ERICKSON: Sure. Well, you know, interest rates go down both ways, don’t you? So, investment grade companies tend to be large companies that are very stable in terms of credit profiles. So if you see a downturn and the reverse is happening and we’re wrong, and we actually get lower rates, that would be an area where investors would benefit, just like they would invest in the treasury market.
And we saw it last year during the March liquidation. Investment grade companies have performed incredibly well due to their long duration and the fact that there has been a massive rally in the Treasury market. So, you know, the length of the game can go either way. So if your point of view is the opposite of where you think rates will actually go down, the investment grade market would be a place to hide and stay invested with companies that have strong balance sheets and strong fundamentals.
BRIAN SOZZI: Monica, before I let you go, I imagine you’re looking at inflation like a hawk. Are you surprised at how stiff inflation looks right now?
MONICA ERICKSON: It’s interesting. I mean, just on a personal note, and I know someone told you about our pets before I did, I just went out and bought some food for my dog. And that was … the prices went up 50%. So I am definitely, on a personal level, seeing inflation. I think what we are hearing from companies is that they are able to push up a lot of their cost inputs. And consumers are prepared to pay these higher prices.
So you know is we’re in an interesting time here where I don’t think most of the people around here have experienced inflation, you know you have to go back to the 70s to get that kind of thing. ‘hyperinflation, which I’m not saying where we are at right now. But it is surprising. You know I’m surprised every day when I go to pay for things how much the goods have gone up.
BRIAN SOZZI: These animals, Monica, must find a job. I mean, start paying for their food. I mean, a 50% increase in pet food is just out of hand. But I guess it’s a sign of the times.
MONICA ERICKSON: I was shocked. Yeah.
BRIAN SOZZI: All right, we’ll stop there. Monica Erickson, Portfolio Manager and Head of Premium Corporate Bonds at DoubleLine Capital, pleased to see you. We will speak with you soon.