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.
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.