The coming recession will create an environment where investment grade corporate bonds will outperform, said Capital Group.
Investment grade bond yields have been widening over the past several quarters and were yielding around 5% at the beginning of the year, but once the economy enters recession, they will outperform high yield bonds, said David Bradin, investment director for fixed income at Capital Group.
He referenced the firm’s multi-sector income fund’s investment strategy, which is available to Singaporean retail investors.
Since the beginning of 2023, the fund has been increasing its credit quality by significantly decreasing its high yield position from a modest overweight to junk bonds last year.
“At the beginning of 2022, we had the least amount of investment grade bonds within the portfolio at about 10% and we are sitting at about 34% right now.”
Although the fund selects its allocations on an issuer by issuer basis, Bradin noted that some areas of the IG corporate bond market are more attractive than others.
Around 10% of assets in the multi-sector fund are bonds issued by high quality investment grade companies in 2020.
“These bonds, which were issued in 2020, are now trading at 60 to 70 cents on the dollar because of the increase in interest rates.”
“The company still has a strong balance sheet and the trajectory and the fundamentals have not changed. But because yields have gone up, the value of these bonds has dropped so it creates a very attractive value proposition in the investment grade space and they are very cheap in our opinion.”
Those opportunities can be found in telecoms companies, leisure companies and media and entertainment companies, he added.
When compared with investing in bonds that were issued in 2021 or 2022 and have a higher coupon rate, Bradin believes bonds issued in 2020 would help to create a degree of convexity in the portfolio.
“When interest rates come back down, those bonds will have more capital appreciation opportunities,” he added.
Although investment grade bonds are likely to generate better returns in the short term, Bradin thinks that does not mean that investors should shy away from high yield.
“I think investment grade would outperform high yield first, but then I would definitely like to rotate into high yield at wider spreads and as they outperform in a recovery expansionary scenario,” said Bradin.
The Capital Group multi-sector income fund was incepted in March 2019.
As of the end of 2022, it has around 34% of its assets invested in investment grade corporate bonds, 30% in high yield bonds and 14% in securitised bonds.
