News - Investment
Fixed income managers have expressed concerns a new bubble may be forming in higher-rated corporate bonds as investors pile into the asset class.
Faced with a deteriorating economic backdrop, managers are wary of taking on more risk by moving down the credit spectrum, but with the yields on A-rated bonds in particular quickly going the way of gilts, they now fear a bubble is forming in the sector.
Investors have been flocking to single ‘A’ assets to counter the low returns on offer from government bonds, particularly in the UK where gilt yields remain near historic lows.
Corporate hybrid bonds – equity-like debt issued by companies such as BG Group and General Electric – have been in demand as part of this trend, having offered attractive coupons.
But Richard Hodges (pictured), manager of the £1.6bn L&G Dynamic Bond trust, said the “mad dash” for A-rated assets is unsustainable. “It does not matter what sector it is – if it has an ‘A’ on it, it is on a buy list,” said Hodges.
“The problem is we have had rallies in the asset class since the start of the year, with the exception of a hiccup in April and May, so the level of performance is now unsustainable for the next six months.”
He added the looming US fiscal cliff, which could wipe 3% off GDP growth next January, will have an adverse effect on global growth and the performance of A-rated assets.
“With this headwind, global markets will remain subdued and investors will find themselves resorting to clipping a coupon, buying high yielding assets to take home a higher level of income,” he said.
Rod Davidson, head of fixed income at Alliance Trust, agreed there are bubbles forming in credit markets in both A-rated assets and the high yield space.
He said investors buying in now stand to lose out in a big way, even if the global economy does pick up.
“As the spreads are now so narrow and the yield has reached a low level, you are damned either way. Balance sheets will be drained if growth slows, and if growth improves, companies are likely to do more corporate actions and use cash to gear up their balance sheets,” said Davidson.
“It is certainly one of the two bubbles in credit which could fall dramatically, as the asset class is currently priced for perfection.”
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