Corporate bonds

Investors would benefit from ‘stable credit profiles, low interest rates’, analyst says

Monica Erickson, investment grade corporate bond portfolio manager at DoubleLine Capital, assesses the state of the corporate bond market and its areas of weakness and profitability for investors.

Video transcript

BRIAN SOZZI: Well, back to inflation here and interest rates. The bond market has come to know only a low interest rate country. This rings especially true for the corporate bond market. Lower interest rates allowed companies to raise considerable cash to support capital expenditures, share buybacks and dividends.

But what will happen to that cash spigot 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 joins us this Friday morning. What’s going on, Monica? We are heading for a land of potentially higher interest rates. What does this mean for corporate bonds?

MONICA ERICKSON: Well, particularly in the investment grade corporate market, one of the things that we at DoubleLine have been talking about for some time is just the level of interest rate risk that the investment grade corporate market presents. The duration of the asset class, ie its sensitivity to interest rates, has increased considerably over time and now stands at around 8.5 years.

So this means that for every 1% change in interest rates, the dollar price of the asset class will move about 8 and 1/2%. It is therefore highly exposed to any type of movement in interest rates. And I think with what you’ve talked about on your show, with — and everybody’s talked about it — with the concern about inflation and still very low interest rates, I think the risk is on the rise. And therefore, the risk is on the downside on higher quality companies.

BRIAN SOZZI: How would we play this potential recovery in volatility?

MONICA ERICKSON: Well, I think you have to have an active bond manager. And I would advise you to keep your duration low at this point. Overall, yields are still very low. If inflation rises, I think at some point we will get higher rates and that will affect returns for the asset class. So the way to protect against that would be to focus on floating rate papers, assets within fixed income securities that would benefit from higher rates.

JULIE HYMAN: Monica, this is Julie here. Now I know you are in the investment grade space. But I have to wonder, as rates rise, what kind of vulnerabilities are we going to see exposed in the corporate bond market and does that mean defaults on the low end or downgrades even in the investment grade? Is that what we’re going to see, or are the companies strong enough now that even with rates going up, there won’t be many?

MONICA ERICKSON: Yeah, 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 in your opinion, in terms of their ability to service their debt and refinance their debt , is incredibly fit. Servicing what we…the cash flow currently available to service debt is 11 times. So EBITDA to interest, which is a metric we look at, is 11 times. It would therefore take a large amount of rate increases to get businesses back to health.

Really, the concern is more on the investor side. And with these super low rates, if you have higher rates, your returns are going to be impacted. But from a fundamental credit perspective, I think the companies are in very good shape. Earnings have been incredibly strong. Companies are now above pre-COVID-19 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 high quality corporate bonds or an index that tracks them as opposed to the actual stocks of some of these companies which are GI rated?

MONICA ERICKSON: Sure. Well, you know, interest rates are cut both ways, right? So, top quality companies tend to be large companies that are very stable in terms of credit profiles. So if you get a downturn and the reverse happens and we get it 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 sell-off. Investment grade corporate bonds performed incredibly well due to their long duration and because there was a massive rally in the Treasury market. So, you know, the duration game can cut both ways. So if your view is the opposite and you believe rates will actually come down, the investment grade market would be a place to hide and stay invested with companies that have strong balance sheets and solid fundamentals.

BRIAN SOZZI: Monica, before I let you go, I imagine you’re watching inflation like a hawk. Are you surprised by the stickiness of inflation at the moment?

MONICA ERICKSON: It’s interesting. I mean, just on a personal note, and I know someone was talking about our pets before me, I just went to buy food for my dog. And it was… prices went up 50%. So I am certainly, on a personal level, witnessing inflation. I think what we’re hearing from companies is that they’re able to forward a lot of their costs. And consumers are willing to pay these higher prices.

So, you know, it’s that we’re in an interesting time here where I don’t think most people around had experienced the inflation, you know, back then – you have to go back to the 70s to get that kind of hyperinflation, which I’m not saying where we are right now. But it is surprising. You know, I am surprised every day when I go to pay for things how much the goods have increased.

BRIAN SOZZI: These animals, Monica, need a job. I mean, start paying for their food. I mean, a 50% increase in pet food is just out of control. But I guess it’s a sign of the times.

MONICA ERICKSON: I was shocked. Yeah.

BRIAN SOZZI: All right, we’ll leave it at that. Monica Erickson, Portfolio Manager and Head of Investment Grade Corporate Bonds at DoubleLine Capital, nice to see you. We’ll talk to you soon.