Fixed income portfolios should take advantage of global investment grade (IG) corporate yields at their highest levels since the global financial crisis nearly 15 years ago.
In Europe, for example, AB says corporate yields are more than 2% higher than 12 months ago, when half the index offered negative yields.
“Today, no European corporate yields are negative. And in just a few months, US corporate yields have risen from 13th percentile to 99th percentile compared with the past 10 years,” explained Vivek Bommi, head of European fixed income at the fund house.
This has led to IG corporate bonds offering the biggest yield advantage over the S&P 500 dividend yield in a decade, while mitigating risk assets’ downside, he added.
Further, today’s credit spreads more than compensate investors for the risk of recession.
Capturing credit potential
While such dynamics bode well for credit investors, many of them remain on the sidelines, based on asset allocations that have underweighted fixed income in recent years amid exceptionally low yields.
Given the turnaround in yields, however, AB expects IG corporate bonds to be a natural first step into the market – in turn positioning the sector for a rally.
“Signs are highly favourable for global investment grade corporates,” said Tiffanie Wong, director, fixed income responsible investing portfolio management at the firm. “Valuations are attractive. Balance sheets are healthy, free cash flow is expanding, profitability is up, and companies are maintaining relatively conservative financial policies.”
The extended period of uncertainty due to the pandemic led companies to manage their balance sheets and liquidity conservatively over the past two years, even as profitability recovered. This was good for improving leverage and coverage ratios, margins and free cash flow.
Among other things, the first half of 2022 has been marked by a higher interest rate regime. By the end of June, prevailing yields for global IG corporate bonds topped 4.3%.
With such unusually strong fundamentals given the imminent economic slowdown, the firm believes credit investors should capitalise on this opportunity.
“Rarely have we seen a better time to invest in investment grade corporate bonds,” added Wong.
Looking past the fear
AB also believes that the market and its outlook for the US, in particular, will benefit from technical conditions that are poised to improve.
For instance, the firm considers the heightened concerns about central bank asset sales to likely be unfounded. This is supported by the fact that the US Federal Reserve hasn’t been a major player in the US IG corporate market.
Even in Europe, which could potentially see the credit market swamped should the European Central Bank (ECB) sell off its sizable IG corporate bond portfolio, AB doesn’t foresee this happening.
“The ECB is likely to hold onto its investment grade corporate bonds and even reinvest the cash flow back into the investment grade credit market, providing further stability for Europe’s credit sector,” said Bommi.