M&G's Woolnough: Where credit's due
In praise of investment grade
As global recession fears recede, investors are slowly coming round to the view that corporate bonds are worth a second look, writes Richard Woolnough, manager of the M&G Optimal Income Bond fund.
It is sometimes as useful to look at past surveys of the corporate credit environment as it is forward-looking ones.
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Those who follow the global findings of the Conference Board will remember the biggest concern for industry bosses worldwide in January was the fear of a recession.
Yet, for some months now, I have been baffled as to why the recession bandwagon has gathered momentum to the extent it has.
As an avid watcher of the credit market, it has been apparent to me a recession is unlikely to occur anytime soon. This is because of the quality of credit on offer - and investment-grade (IG) credit in particular.
If a recession were just around the corner, I would not expect IG bonds to display such good value, both relative to history, and in relation to high-yield bonds.
In fact, I would go even further by saying that, currently, IG corporate bonds represent the best overall relative value within the entire bond market.
They have rallied less than their high yield counterparts (5.5% for IG versus 8.8% for high yield year-to-date) courtesy of a first quarter earnings season in the US that has produced fewer negative surprises than first thought and helped support bonds of a lesser quality.
A limited supply of high yield investments has also led to a rally in prices of the asset class. As a result, the difference in value between corporate IG bonds and high yield bonds has rarely favoured IG investments to the extent it does currently.
Additionally, relative to sovereign bonds, corporate bonds display value. 10-year Bund yields, which hover between negative and positive territory in Germany, present investors with no value whatsoever... although eurozone index-linked bonds, particularly those of France and Germany, prove the possible exceptions to that rule.
In the UK, with gilts offering just over 1%, these bonds sit on the equivalent of a company with a P/E multiple of 100 times. Given the paucity of yields on offer in the sovereign bond market, it is little wonder investors (albeit reluctantly) are turning to equity markets for their income requirements.
Within corporate bonds, my favourite area of the market remains companies with the ability to defend their BBB status. Corporate managements are all too aware that if their credit ratings slip, their businesses are in trouble and jobs are lost.
There are good reasons to believe credit spreads are likely to narrow going forward.
While the degree of M&A activity fades in the corporate bond market, President Donald Trump is being forced to turn on the US Treasury tap once more.
There are justifiable factors (namely a Presidential Election in 2020) as to why he is intent on pushing through his promised infrastructure and other government-funded programmes.
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To attract enough buyers though, at some stage, sovereign bond yields will have to rise from current levels. For watchers of credit spreads, that represents yet another reason to give corporate bonds a second look.
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