In a still unpredictable environment, global investment-grade credit could offer the potential for capital gains, income and liquidity.
As the dust settles after the enormous market volatility in March and April, we are all having to reset our expectations for asset class returns. The prospects for capital gains, income and liquidity have changed. In this new and still unpredictable environment, investments in global investment-grade credit could offer the potential for all three.
While still digesting the impacts of COVID-19 and the consequent global lockdowns, it is clear to us that some sectors look extremely challenged fundamentally. Nobody can yet be certain whether we will look back on this as a short period of demand destruction, or something that changes the way we operate in society forever. Fundamental analysis in those areas most impacted is extremely difficult and needs to focus largely on liquidity; can these operators survive through a sustained downturn? Corporate issuers in these sectors are a very small part of the global investment-grade credit universe with aerospace, airlines, gaming, lodging, entertainment and restaurants collectively amounting to just 1.5% of the global investment-grade credit bonds outstanding, according to the Bloomberg Barclays Global Credit Index. The remaining 98.5% of the universe is more robust and can be modelled for significant contractions in global growth. Take the banks for example—central bank stress tests continue to report on the considerable capital build in this sector and we expect resilience for quality banks, even down the capital structure in subordinated bonds. Many non-cyclical credits are well positioned with healthy balance sheets and sizeable liquidity buffers. There will be downgrades and losers within global IG, given the extremity of the economic shock, but we think valuations are compelling for fundamentally stronger names, bringing opportunities for capital gains.
So what about income? Global Investment Grade Corporate bonds currently trade with an average spread of 1.8%.* This premium provides a high level of income versus very low yielding developed market global government bonds. Turning to equity markets, the recent swathe of dividend cuts and suspensions is a challenge for global investors seeking income and brings considerable uncertainty as to dividends being paid over the coming quarters. The correction in stocks has made dividend yields more attractive than at the start of the year given the fall in equity valuations but even now the S&P 500’s dividend yield is only around 2%. In Europe, meanwhile payouts may be as much as 50% lower in 2020 than in 2019 and dividend futures still price further dividend cuts.
Liquidity was always a hallmark of investment grade credit, but in late March even US Treasuries were struggling to trade efficiently. Since then we have had a considerable central bank response, with a keen eye on restoring liquidity to not only government bond markets but also to investment-grade credit markets. For the first time starting on May 12, the Federal Reserve is buying US investment-grade corporate credit, initially via ETFs, and states in its objectives that it wishes “to facilitate orderly repositioning and pricing of risk.” Meanwhile, the BoE has resumed its corporate asset purchases and the ECB has increased the size of its programmes. These schemes may not serve to send spreads meaningfully tighter but they will provide a meaningful liquidity backstop in times of crisis and have enabled corporates to issue bonds actively once again in the primary markets.
With credit spreads meaningfully wider, we believe investors can take advantage of the current market dislocations and generous concessions to buy assets at historically attractive yield spreads. Dispersion in returns is likely making security selection paramount and a wider global opportunity set desirable. Our bias in the near term is on high-quality issuers that can endure through a prolonged period of economic uncertainty; there is no need to reach for more precarious credits. We expect to see ongoing interest in the asset class.
Exhibit 1: Bloomberg Barclays Global Aggregate Corporate Index OAS
Source: Bloomberg Barclays. As of 14 May 20. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.
* Note: The option-adjusted spread (OAS) of Bloomberg Global Corporate Bond Index (LGCPOAS) was 1.81% as at 28th March 2020.
Learn more about Western Asset's Fixed Income solutions:
Legg Mason Western Asset Australian Bond Fund
Legg Mason Western Asset Cash Plus Fund
Legg Mason Western Asset Global Bond Fund
Legg Mason Western Asset Macro Opportunities Bond Fund
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.
COVID-19 is the World Health Organization's official designation of the current novel coronavirus disease. The virus causing the novel coronavirus disease is known as SARSCoV-2.
The Bloomberg Barclays Global Aggregate Index is a measure of global investment grade debt from twenty-four local currency markets. This multi-currency benchmark includes treasury, government-related, corporate and securitized fixed-rate bonds from both developed and emerging markets issuers.
The Bloomberg Barclays Global Agg Corporate Index is a measure of global investment grade (IG) fixed-rate corporate debt. This multi-currency benchmark includes bonds from developed and emerging markets issuers within the industrial, utility and financial sectors.
A yield spread or credit spread is the difference in yield between two different types of fixed income securities with similar maturities.
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.
The S&P 500 Index is an unmanaged index of 500 stocks that is generally representative of the performance of larger companies in the U.S.
The Bank of England (BOE) is the central bank of the United Kingdom.
The European Central Bank (ECB) is the central bank for the European Union (EU).
Exchange Traded Funds (ETF) are a type of investment company which are bought and sold on a securities exchange. ETFs generally represent a fixed portfolio of securities, derivative instruments, currencies or commodities. The risks of owning an ETF generally reflect the risks of owning the underlying securities or commodities they are designed to track. ETFs also have management fees and operating expenses that increase their costs
Backstop is a term used in the financial industry to mean credit support or backup funds for a financial instrument or transaction.
Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.
All investments involve risk, including possible loss of principal.
The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested.
Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.
International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.
Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.
Past performance is no guarantee of future results. Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.
The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice. Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.
The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).
This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc. Unless otherwise noted the "$" (dollar sign) represents U.S. Dollars.
This material is only for distribution in those countries and to those recipients listed.
All investors and eligible counterparties in EU and EEA countries:
In Europe (excluding UK and Switzerland), this financial promotion is issued by Legg Mason Investments (Ireland) Limited, registered office Floor 6, Building Three, Number One, Ballsbridge, 126 Pembroke Road, Ballsbridge, Dublin 4. D04 EP27, Ireland. Registered in Ireland, Company No. 271887. Authorised and regulated by the Central Bank of Ireland.
In the UK, this financial promotion is issued by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the UK Financial Conduct Authority.
In Switzerland, this financial promotion is issued by Legg Mason Investments (Switzerland) GmbH.
Investors in Switzerland: The representative in Switzerland is FIRST INDEPENDENT FUND SERVICES LTD., Klausstrasse 33, 8008 Zurich, Switzerland and the paying agent in Switzerland is NPB Neue Privat Bank AG, Limmatquai 1, 8024 Zurich, Switzerland. Copies of the Articles of Association, the Prospectus, the Key Investor Information documents and the annual and semi-annual reports of the Company may be obtained free of charge from the representative in Switzerland.
All Investors in Hong Kong and Singapore:
This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore.
This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.
All Investors in the People’s Republic of China (“PRC”):
This material is provided by Legg Mason Asset Management Hong Kong Limited to intended recipients in the PRC. The content of this document is only for Press or the PRC investors investing in the QDII Product offered by PRC’s commercial bank in accordance with the regulation of China Banking Regulatory Commission. Investors should read the offering document prior to any subscription. Please seek advice from PRC’s commercial banks and/or other professional advisors, if necessary. Please note that Legg Mason and its affiliates are the Managers of the offshore funds invested by QDII Products only. Legg Mason and its affiliates are not authorized by any regulatory authority to conduct business or investment activities in China.
This material has not been reviewed by any regulatory authority in the PRC.
Distributors and existing investors in Korea and Distributors in Taiwan:
This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (109) Jin Guan Tou Gu Xin Zi Di 016; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.
This material has not been reviewed by any regulatory authority in Korea or Taiwan.
All Investors in the Americas:
This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which includes Legg Mason Americas International. Legg Mason Investor Services, LLC, Member FINRA/SIPC, and all entities mentioned are subsidiaries of Legg Mason, Inc.
All Investors in Australia and New Zealand:
This document is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827). The information in this document is of a general nature only and is not intended to be, and is not, a complete or definitive statement of matters described in it. It has not been prepared to take into account the investment objectives, financial objectives or particular needs of any particular person.