“The best value investment grade market I have seen” - corporate bond managers say they are finding bargains. Should advisers be taking note?
- Spreads have widened significantly for corporate bonds, creating real value in the sector, say corporate bond managers
- Indiscriminate selling means corporate bonds now offer a higher income and scope for capital growth
- Discernment is crucial in an environment where defaults will rise
The coronavirus outbreak has changed pretty much everything, not least the outlook for corporate bonds. At the start of 2020, no-one wanted anything to do with corporate credit – it was, many concluded, too expensive, too illiquid and investor protections had gradually been eroded. Now, it appears, many asset allocators can’t get enough of it.
Partly this is a valuation issue. Spreads have widened enormously, to the extent that corporate bonds now offer a decent income and scope for capital appreciation. This has prompted considerable enthusiasm among corporate bond managers. “Probably the best value investment grade market I have seen in my career,” says Ben Edwards, manager of BlackRock Corporate Bond.
The sell-off has been largely indiscriminate, which has left higher quality bonds looking cheap. Stephen Snowdon, manager of the Artemis Corporate Bond, said: “We sold some riskier bonds to buy higher quality replacements, and you’d think doing that would involve a big drop in yield - but no. The first two deals came so cheaply we could improve the quality of the fund without dropping too much in credit spread.”
Corporate bonds also have a structural advantage in this environment. While companies can forgo dividends to shore up their cashflow, companies are legally obliged to meet their debt obligations. As such, while dividends have been widely cut, the income from corporate bonds has remained in tact.
Having said all this, there are clearly problems ahead for some areas. Corporate earnings are likely to deteriorate for the foreseeable future and the current round of corporate failures is, almost certainly, just the beginning. Unquestionably, defaults will rise. Corporate bond managers aren’t arguing against that but suggest that the market has been pricing in defaults across the board, even where companies aren’t showing distress.
However, it argues for an active rather than a passive approach. Passive benchmarks are often weighted to the most indebted companies, which may be extremely vulnerable today.
Another consideration may be whether a fund is in inflow or outflow. There are some behemoth funds out there and the corporate bond market is illiquid. It is possible that some larger funds experiencing outflows will not be in a position to take advantage of this environment. Smaller funds may be more nimble and flexible.
For the longer-term investor, there are a wealth of cheap assets today. However, buying opportunities for higher quality corporate bonds have been few and far between in recent years. Now may be a good time to revisit the sector.
