HUB EXCLUSIVES PANEL DISCUSSION 2023 – THE OUTLOOK FOR CORPORATE BONDS AS THE ECONOMY SLOWS
Panel discussion, hosted by Cherry Reynard, with:
Hilary Blandy, Investment Manager at Jupiter Asset Management,
Ed Harrold, Investment Director at Capital Group
and Connor Godsell, Investment Analyst at abrdn
High corporate bond yields have drawn investors to the asset class since the start of the year, but the banking turmoil have proved a timely reminder of the risks. At the same time, the sector faces the prospect of rising default rates as growth weakens. What are the prospects for the sector today?
By late February, $19bn had moved into investment grade corporate bonds since the start of the year . Investors had been drawn by higher yields after a year of significant adjustment in 2022. However, the asset class was hit by the fall-out from Silicon Valley Bank, with spreads widening and investors exiting.
For the time being, investors must weigh higher yields with weaker economic growth prospects, which may raise default rates. Hilary Blandy, investment manager, fixed income at Jupiter Asset Management, says: “In general, in a weaker economy, default rates would increase, though it’s extremely rare to see defaults in investment grade credit. There may be some spread widening, reflecting some weaker earnings profiles. High yield bonds will be more vulnerable.”
She points out that default rates have been exceptionally low and some increase is inevitable. However, she points out that the number of bond maturing in 2023 and 2024 is low, adding: “There are some more troubled credits, but not a long list of potential default candidates.”
She says the key risk is among higher yield credits who will refinance at a far higher rate when the time comes: “What we might see is the more indebted companies, where the structures looked fine in a lower interest environment, that those structures become unsustainable. However, yields are very attractive, wider than they’ve been for many years. When yields are this high, we typically see very strong returns. While defaults will tick up, strong credit research should be able to sidestep those defaults.”
Credit spreads
Connor Godsell, investment analyst, fixed income at abrdn, pricing looks more realistic across corporate bonds after the recent widening of spreads. He says: “The pricing of investment grade credit is close to where we’ve seen it in the period before previous recessions. In the longer-term, it appears to offer decent opportunities.”
The banking problems have also led to a dearth of issuance, which should help to support prices. Ed Harrold, investment director, fixed income at Capital Group, says: “March has limited deals in the European investment grade market, in significant contrast to the year to date, when issuance has been quite strong. We had seen companies trying to get ahead of higher rates earlier in the year.”
Credit positioning
Blandy believes the strongest opportunities lie in shorter-dated higher yield credit: “When yield curves are inverted, investors are not really getting paid to invest in longer-dated bonds. There are better yields at the front end. In this environment, blending short-dated investment grade and high yield bonds makes sense. It keeps interest rate risk low and helps create a portfolio that can perform in a range of different inflation scenarios, generating attractive income levels but with a moderate risk profile.” She is also focusing on recession-resilient sectors, such as TMT or pharma.
Godsell is also looking at higher quality bonds in more resilient sectors that are less likely to be impacted if there is a sudden or severe growth slowdown. He says: “This includes infrastructure assets, including airports and logistics providers. We are limiting exposure to some of those more consumer-facing sectors likely to be hit hardest by economic weakness.” Harrold has used the recent weakness to raise the weighting in stronger companies in more senior parts of the capital structure.
Either way, the asset class is presenting significant opportunities. Blandy says that one of the worst years on record for corporate bonds has undoubtedly created an attractive entry point: “Whatever happens with inflation and interest rates, we know we’re not going to see the same rises in interest rates. Investors haven’t been able to buy bonds at these levels for many years. It’s the type of opportunity we don’t see very often and yields offer a good cushion for any downside risk.”
Godsell agrees: “We could even argue that the current banking fragility and the resultant repricing has been healthy and reminds us that creative destruction is a real force. Given where spreads are now, there is attractive compensation for risks taken.”
Recent spread widening has given investors a chance to reinvest in corporate bonds at more compelling yields, but credit selection will become more important in an environment of weaker growth.
