Not all BBB bonds are created equal
The growth of BBB credit since the Global Financial Crisis has received a lot of attention.
Many argue, as we would, that maintaining BBB exposure is warranted given their superior income and return prospects. However, discerning credit analysis is key to maintaining sustainable exposure as not all BBBs are the same.
To briefly reframe the debate, the growing BBB market now represents roughly 50% of the total market capitalisation of investment grade (IG), with about $1trn of debt sitting one notch above high yield.
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Alongside this, leverage within the space has increased too. The rating agency justification for this is that interest rates are low and profit margins high, so issuers can afford this debt.
Plus, growth in the BBB market has been dominated by defensive sectors, which are typically more resilient to the economic cycle and tend to have a portfolio of cash generative assets that can be monetised even in a downturn.
Despite concerns, we struggle to identify how the BBB space can be the catalyst for a turn in the cycle, but recognise the imbalances built will be a source of pain when risk markets crack.
It is hard for investors to ignore the ten-year cumulative 48% outperformance of sterling BBBs over single-As, and since 1996 there have only been five years of BBBs underperforming single-As. The yield advantage of BBBs is a strong tide to swim against.
If BBBs are to form part of a portfolio, where should investors focus? Looking at the sterling market and the weighting of merger and acquisition-fuelled BBBs, consumer and healthcare has a lower percentage, with a greater emphasis on utilities and real estate versus the US.
Neither region is without its challenges, but the froth of the US consumer names is notably absent. Digging deeper, our focus is on stable cash flows businesses with solid asset backing.
There is a time for cyclical BBBs, but late in the cycle is not it. Asset backed securities (ABS), real estate and utilities offer both characteristics and come with the robust covenant and security packages often missing from straight corporate debt.
Kristian Atkinson is portfolio manager on the Fidelity MoneyBuilder Income fund
Bull Points
• Growth has been in non-cyclical sectors, which are better positioned to weather an economic downturn
• ABS, real estate and utilities tend to be stable cash flows business with solid asset backing
Bear Points
• BBB market has grown five times in the last decade, representing 50% of the global investment grade credit market
• Leverage within the BBB space has increased
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