Many developed countries have experienced low interest rate environments since 2009 as central banks cut policy rates to stimulate economic growth in response to the global financial crisis.
As a result, retail investors have struggled to find secure income and institutions have struggled to find assets with sufficient yield to match their liabilities, without moving down the credit curve and buying riskier fixed income securities.
If the task was difficult before the coronavirus pandemic, it is even tougher now. Central banks have slashed short-term rates and investors have rushed to buy “safe” US government bonds which sent the bellwether US Treasury yield to an all-time low of 0.32% in early March.
Meanwhile, central banks led by the US Federal Reserve are spending billions of dollars purchasing corporate debt, including so-called “fallen angels”, that is, bonds that have been downgraded to below investment grade. Many companies’ ability to service the interest on their bonds remains precarious, but investors are forced to supplement their credit analysis with expectations of price support which is, at best, likely to be unsustainable.
Recommendations from wealth managers range across the credit spectrum, from sticking with the best quality investment grade fixed income to selective buying of high yield or emerging market bonds.
Patrick Ho, chief market strategist for North Asia at HSBC Private Banking argues that the very low interest rate environment should support US dollar and global investment grade bonds.
“The extraordinary policy support has reduced the risk of a credit crisis developing, especially in the investment grade bond market,” he said.
Deutsche Bank Wealth Management also thinks the sector is attractive, while UBS Global Wealth Management is increasing its overweight to US investment grade bonds in its portfolios.
“The spread [over US Treasury yields] on US investment grade has narrowed from around 290 basis points (bps) when we first initiated an overweight on 30 March, to slightly below 200bps on 20 April. [But], we believe it will contract to 150bps and…even end the year at around 100bps,” said Adrian Zuercher, head of asset allocation in Apac for UBS Global Wealth Management’s chief investment office.
Yet at current low rates, most agree with Ken Peng, Asia-Pacific investment strategist at Citi Private Bank, that there is scarce value in developed market sovereign bonds, including US Treasuries.
Peng favours investment grade credit in the US and also in Asia, “as spreads still have room to narrow”.
Credit risk
In addition, Peng points out that high yield credit spreads are at the widest since the global financial crisis, and although they are likely to see continued volatility, spreads could narrow significantly if global economic recovery takes place.
China property is UBS GWM’s preferred exposure in high yield, with an emphasis on “good quality BB-rated bonds that have sold off, as well as shorter-dated bonds”, said Zuercher.
Although Deutsche Bank WM’s head of chief investment office for emerging markets, Jason Liu, believes high yield fixed income is “risky in the current environment”, he likes emerging market hard currency bonds, particularly China issuers, “due to domestic monetary easing measures, production picking up and the US interest rate cuts”.
In fact, as Hou Wey Fook, chief investment officer at DBS Bank, points out, the conventional playbook of modest growth and easy monetary policy dictate that higher yielding assets should be well supported.
Hou thinks that Asia credits and subordinated AT1 bank bonds offer attractive risk-reward features and believes that the crisis “gave rise to opportunities to pick up fallen corporate angels, which typically have done well after they have been downgraded”.
