Market Views: What to buy in the US corporate bond market?
September has seen record enthusiasm from both issuers and investors participating in the US corporate bond market.
While the week after Labour Day in the US historically tends to be busy in debt markets, this year's had one of the highest weekly issuances on record in the investment-grade primary market, with $78 billion worth of bonds being issued - more than half the total $150 billion to $160 billion expected for September.
Companies are incentivised to take advantage of the low sovereign yields and low borrowing costs ahead of the Federal Reserve raising interest rates by early 2023.
Demand from global investors has also been robust and well absorbed by the market with issues being on average three times oversubscribed.
For high-yield bonds, Wall Street estimates for September sales range from $35 billion to $60 billion, according to six banks surveyed by Bloomberg, with offerings likely to include acquisitions and leveraged buyouts.
Fund managers told AsianInvestor that they are looking at high-risk debt, from BBB-rated bonds and lower across the credit rating spectrum. Sector-wise, fund managers said they favour sustainable themes, energy and banks.
AsianInvestor asked fund managers how Asian asset owners are participating in the corporate bond market, and which sectors they find the most attractive.
The following contributions have been edited for brevity and clarity.
Kevin Anderson, head of investments, APAC
State Street Global Advisors
Asset owners, starved of yields from government bonds, have been increasing allocations into corporate credit. Recently, investors have preferred the leveraged loan sector, as opposed to corporate high-yield bonds, on expectations of tighter policy from the Federal Reserve.
We are in a mid-cycle environment with strong but moderating growth, and less easy monetary policy. Hence, we believe corporate credit returns hereon would be more driven by carry, rather than outright spread compression, and that growth-sensitive assets should do better than duration-sensitive assets.
Thus, we prefer high-yield credit over investment grade, and leveraged loans over high yield bonds. Our preference for loans is not only based on their floating-rate nature but also because collateralised loan obligation (CLO) issuance, a key area of demand for loans has stayed strong in 2021. Risks to watch out for are stretched valuations, as well as concerns about growth peak.
Karan Talwar, client portfolio manager, global high yield
Barings
While demand from the US retail channel into high-yield bonds has been a headwind this year, reversing some of the sizeable inflows from 2020, demand from other sources including institutional investors has remained resilient as the market remains in search of income/yield in the current low-interest rate environment. Specific to the Barings high-yield bond funds, we have also observed strong demand in 2021 from clients in Asia.
From a credit fundamental standpoint, US issuers broadly appear to be on solid footing. Company earnings and cash flows are expected to remain well supported by the resurgence in consumer demand this year and into 2022. Accelerating economic growth and improving corporate financial conditions, coupled with a manageable default picture, should also bolster the market.
With this backdrop, we selectively favour opportunities lower down the credit rating spectrum across high yield, albeit with careful emphasis on security selection (e.g. positioning within the capital structure). With expectations for continued economic growth coming out of the pandemic, there are also benefits to considering floating-rate assets such as loans, which can decrease sensitivity to short-term interest rates. Loans are also senior in the capital structure, meaning they are paid back ahead of subordinated debt and equity, and secured by some or all of a borrower’s assets, offering further credit protection.
Lyndon Man, co-Head of global investment grade credit
Invesco
In our view, in an environment where you have a central bank that are willing to look beyond near-term inflationary pressures and focus on longer-term risks, for example: Covid-induced demand-side destruction and negative supply shocks; it will be conducive for high-quality fixed income products like corporate bonds, where the credit spreads on offer will provide a decent carry and duration will provide a hedge to renewed growth concerns.
We find banks, in particular bonds lower down the capital structure like contingent convertibles (CoCos) and Tier 1 debt as attractive given the strong improvement in the levels of capitalisation and to benefit should we see risks of a reflation.
We also see selective opportunities within the energy sector especially in issuers who have been focusing on decarbonisation strategies and have committed to aligning with the Paris agreement. Elsewhere, we see idiosyncratic opportunities from a rising star perspective especially in cyclical sectors like in Autos, which will benefit from in a post-pandemic recovery environment.
Brendan Circle, portfolio manager, Franklin Income Fund
Franklin Templeton
In our strategies, we are more cautious of lending at current levels. The investment grade market is hovering around record low spread levels which creates a low absolute yield opportunity given sovereign yield levels. Additionally, companies have steadily increased their duration profiles over the last few years which increases interest rate sensitivity. Our expectation of modestly higher interest rates over time leaves us with a poor total return outlook for investors in the investment grade market.
We have a more constructive view of the high yield market within the fixed income opportunity set. Credit quality in the high yield market has increased over time, the duration of the asset class is less than half of the investment grade market, and strong corporate fundamentals all benefit the high yield market. Low spread compensation leaves us keenly focused on security selection and credit quality, but we do not see the same diminished total return setup. We have been focused on shorter maturity opportunities within the high yield market recently. We expect a higher level of issuance over the next few weeks as a number of mergers and acquisitions (M&As) related financing are in queues, but we have not seen a deluge of high yield issuance thus far in September.
Frank Olszewski, head of investment grade active US credit
AXA Investment Managers
Despite heavy US corporate bond issuance activity, we remain constructive on the investment grade market. The strength of the economic recovery, extraordinary monetary accommodation and added fiscal stimulus continue to support credit fundamentals.
Despite valuations not being historically cheap, the strong macro backdrop and positive technical fundamentals continue to support spreads. There is little deviation between sectors within the US investment grade market today as industries that were hardest hit by the pandemic have mostly recovered, leaving little opportunity to add much alpha from sector rotation.
As such, we continue to see lower credit quality bonds as particularly attractive. Security selection is paramount as our credit analysis is focused on identifying potential credit deterioration, particularly management teams that may stretch their financial policies at this stage of the cycle. We feel that the market will continue to place a premium on ESG-minded companies, particularly those that have issued green, social and sustainable bonds. We also favour shorter duration assets as the risk of somewhat higher interest rates remains.
The main tail risks that could alter the rosy outlook remain the Delta variant, Fed tapering and a lack of credit discipline from corporate treasurers that allows capital allocation policies to favour the equity shareholder over the bondholder.
Michael Cross, global CIO fixed income
HSBC Asset Management
Investors are taking advantage of a number of tailwinds in the US corporate bond market: strong fundamentals, higher yields and slightly higher spreads in US compared to other markets such as euro corporate bonds and low-rate volatility thanks to benign central banks. Furthermore, hedging costs for many overseas investors have also come down since the pandemic, making USD investments attractive.
In our flexible investment grade portfolios, we have been deploying a barbell strategy: we have been moving up in ratings quality given the strong spread compensation from A to BBB issuers. This shields us from any spread volatility from the lower quality ratings, but has also helped us to increase the portfolio’s ESG score versus the benchmark. On the other hand, this is offset with some BB names our credit analysts have identified as rising starts. We still believe in the post-pandemic recovery trade which favours cyclicals over non-cyclicals and have therefore found some interesting opportunities in sectors such as transportation and aircraft lessors.
There are definitely risks to watch out for. If inflation is not as transitory as the market is currently pricing in, that could provoke central bank action causing volatility in rates. So even if corporate fundamentals are strong, a backup in yields could cause a temporary period of underperformance which we would most likely see as an opportunity to add back risk.
David Del Vecchio, co-head of US investment grade corporate bonds
PGIM Fixed Income
We see the most value in banks, energy, BBBs with strong or improving balance sheets, bonds with attractive spreads in the short end of the market, and select 20-year and 30-year bonds.
Some of the risks to consider are any moves to a less dovish stance by the US Federal Open Market Committee (FOMC) and the European Central Bank (ECB), a potential shift in management priorities from debt reduction and leverage improvement to more shareholder-friendly activities like acquisitions, share buybacks or dividends.
Other risks include margin pressure resulting from cost pressures and supply chain issues, the “pay fors” in the infrastructure package making its way through Congress and the potential for increasing levels of regulatory scrutiny on the business sector.
Ryan Mostafa, portfolio manager, US multi-sector fixed income
Schroders
In spite of the supply surge, broad market spreads are unchanged to slightly tighter and the new issues have performed well after pricing so far this month, which speaks to the underlying strength of demand and engagement by investors as well as the fact that net supply is manageable due to elevated bond maturities and tender activity by issuers.
With spreads hovering near record tights for the investment grade market – especially after adjusting for ratings and duration – the relative benefit of participating in the primary market is elevated as transaction costs in the secondary market, which do not change very much over time, are high as a percentage of overall spread levels. As a result, our team has continued to look to the primary market as critical for adding incremental exposure in order to minimise transaction costs and capture new issue premiums to the extent they exist.
Our team continues to find value in the BBB segment of the market and in more cyclical sectors and issuers that have been leading deleveraging and agency upgrades this year and where relatively attractive spreads can still be found. Broadly, higher-quality industrial issuers have greater incentive to engage in shareholder-friendly initiatives and M&A relative to BBBs, and have less compelling upside as a result.