COVID-19: Fixed Income Update

Monthly review

COVID-19: Fixed Income Update

Brandywine Global examines the recent impact on various bond sectors from COVID-19 pandemic.

The week of March 23, U.S. investment grade new issuance hit a post-2008 crisis high on a year- over-year basis (see Figure 1) after the Federal Reserve (Fed) provided a backstop for high-quality corporate credit. Central bank support for U.S. investment grade credit piqued investor interest in this higher-quality, long-duration alternative to the 10-year U.S. Treasury, which has continued to trade at historically expensive levels, as shown in Figure 2.

Figure 1: Year-Over-Year U.S. Investment Grade New Issuance

As of 4/21/2020

Figure 2: 10-Year Treasury Bond Model

As of 4/21/2020

Figures 1, Source: Bloomberg Finance, L.P.  Figure 2: * Estimation interval: 1998M1 - 2020/03. Source: Brandywine Global. Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.


Investment grade option-adjusted spreads have notably contracted over a one-month period due to the combination of investor demand and anticipated Fed purchases, as shown in Figure 3.

Figure 3: U.S. Investment-Grade and High Yield OAS

As of 4/20/2020

Source: Bloomberg. Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.


While April 2020 new issuance remained strong on a year-over-year basis, there was a $100B contraction in activity from the month prior (see Figure 4).

Figure 4: Monthly Rolling U.S. Investment Grade New Issuance

As of 4/21/2020

Source: Bloomberg Finance, L.P. Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.


With investment grade new issuance activity potentially normalizing to pre-pandemic levels, investors may be signaling demand for spread-compression opportunities beyond high-quality corporate debt. While we believe opportunities in high yield and securitized credit will arise over the next 6-12 months, we think select opportunities will continue to present themselves within the investment grade corporate credit universe.

Figure 5 shows the top investment grade issuers in April. We believe this is the right mix of investment grade issuers coming to the market. The financials sector is largely comprised of multinational, U.S.-based banks that have been well capitalized since the Great Financial Crisis. Incidentally, the financials sector led March issuance activity, and we purchased several new issues given the value opportunity, strong fundamentals, and clean balance sheets. We will look for these traits on a case-by-case basis when evaluating purchases within investment grade credit. Aside from large financial institutions, we believe that multinationals within industrials exhibit these qualities. We are also interested in companies that stand to benefit from fiscal stimulus packages and the gradual economic recovery, such as names in telecom. Since earnings will be eroded across the board, we believe it is important to buy the bonds of companies that hold significant amounts of cash on their balance sheets so they can weather several months of flat or no revenue. A strong cash position is one of the reasons why we found an attractive select new issuance opportunity within the energy sector, although we are extremely cautious about the industry in general.


Figure 5: Top 10 U.S. Investment Grade Deals in April 2020

As of 4/21/2020

Figure 6

Figure 5: Source: Bloomberg Finance, L.P.  Figure 6: Sources  Barclays, Brandywine Global. Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.


Most of the issuers in Figure 5 fall in line with our investment thesis, although there are more economically sensitive businesses included, such as auto manufacturers. With companies like Ford coming to the new issuance market, some investors are trying to assess the fallen angel opportunities, as this particularly example is on the precipice of high-yield status with its split rating. Since credit ratings downgrades usually occur on a lag, company-specific bond yields have likely priced in this expected change in information.

We believe that companies that are most vulnerable to the shock in oil prices and the pandemic-related economic slowdown will be most susceptible to a credit ratings downgrade. Energy and any cyclically oriented sectors will likely be the most vulnerable. During the first half of 2020, fallen angels’ outstanding debt should account for an estimated $300-$350B volume of activity relative to the investment grade index. For the year, the dollar amount could be $650-$700B in total volume or 7%- 12% of the index. While this may seem extreme, the projected levels of downgrade activity remain lower when compared to other recent crises as shown in Figure 6.


With liquidity top of mind, we will prudently assess whether we should add any high yield credit exposure to our eligible Global Fixed Income strategies. With borrowing costs expected to rise for lower-quality issuers, we expect traditional metrics like leverage ratios to broadly increase, particularly within the high yield universe. Therefore, it is unsurprising that new deals within the high yield segment have significantly lagged in this challenged environment. Figure 7 illustrates that current high yield new issuance has remained anchored at the trough seen during the Great Financial Crisis.

Figure 7: Year-Over-Year U.S. High Yield New Issuance

As of 4/21/2020

Figure 8: Monthly Rolling U.S. High Yield New Issuance

As of 4/21/2020

Figures 7, 8: Source: Bloomberg Finance L.P.  Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.


Although high yield issuance hasn’t returned to levels seen in the year prior, April activity seems to have rebounded from the lull in March, as shown in Figure 8. This revival in activity may suggest that investors may be willing to move down in credit quality for higher-yielding opportunities.

A wide variety of high yield companies are tapping the new issuance market, including defense/aerospace, industrials, energy, consumer discretionary, and healthcare (see Figure 9).

Figure 9: Top 10 U.S. High Yield Deals in April 2020

As of 4/21/2020

Source: Bloomberg Finance, L.P. Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.


While there may be opportunities on a case by case basis, most of these top issuers are economically sensitive and at the mercy of regional or country-specific recoveries. Additionally, the high yield universe is anticipated to grow as fallen angels enter the market, which may alter supply-demand technicals over the next three-12 months.


COVID-19 is the World Health Organization's official designation of the current novel coronavirus disease.

A pandemic is the worldwide spread of a new disease.

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

A central bank is a national bank that provides financial and banking services for its country's government and commercial banking system, as well as implementing the government's monetary policy and issuing currency.

Investment-grade bonds are those rated Aaa, Aa, A and Baa by Moody’s Investors Service and AAA, AA, A and BBB by Standard & Poor’s Ratings Service, or that have an equivalent rating by a nationally recognized statistical rating organization or are determined by the manager to be of equivalent quality.

U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.

An Option-Adjusted Spread (OAS) is a measure of risk that shows credit spreads with adjustments made to neutralize the impact of embedded options. A credit spread is the difference in yield between two different types of fixed income securities with similar maturities.

High yield bonds, also called junk bonds, are bonds with below investment-grade ratings (BB, B, CCC for example) and are considered low credit quality and have a higher risk of default.

The Great Recession, also known as the financial crisis of 2007–08, the Great Financial Crisis (GFC), global financial crisis and the 2008 financial crisis, was a severe worldwide economic crisis considered by many economists to have been the most serious financial crisis since the Great Depression of the 1930s, to which it is often compared.

The European debt crisis (often also referred to as the eurozone crisis or the European sovereign debt crisis) is a multi-year debt crisis that has been taking place in the European Union since the end of 2009. Several eurozone member states (Greece, Portugal, Ireland, Spain and Cyprus) were unable to repay or refinance their government debt or to bail out over-indebted banks under their national supervision without the assistance of third parties like other eurozone countries, the European Central Bank (ECB), or the International Monetary Fund (IMF).

The 2016 energy crisis refers to the rapid fall in the price of crude oil in the latter part of that year.


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