“In this environment, interest rates and US Treasury yields are likely to fall. Yet corporate bond spreads are not very generous and, especially down the credit curve, are insufficient to compensate for the risks of weaker corporate earnings.”
Meijers was discussing the Netherlands-based Robeco SAM SDG Credits strategy, managed by Reinout Schapers and Victor Verberk. The strategy’s most dominant characteristic now is “defensive”, although it can allocate to high yield and emerging market bonds.
But, Meijers argued, be aware that an earnings contraction is underway in the US and corporate leverage is also historically high.
He therefore recommends that investors “stick to top quality investment grade bonds” if they want credit exposure, and avoid high yield bonds, whose issuers are especially vulnerable to the effects of slower growth on earnings and cash flow generation to service or refinance their debt.
“When the Fed cuts interest rates, it is usually negative for high yield bonds because it reflects an imminent or current economic slowdown.”
Schroders is another manager who has recently warned about holding high yield bonds.
Yield hunt in Europe
Elsewhere, the European Central Bank (ECB) has indicated that it will be reintroducing quantitative easing – that is a policy of asset purchases by the ECB – to stimulate Europe’s still moribund economies, which will push interest rates down even further on the continent.
“So the search for incremental yield is back on in Europe,” Meijers said.
But, investors should avoid moving down the credit curve in the hope of earning more income or enhancing returns, because volatility is likely to rise for high yield bonds, according to Meijers.
However, the outlook for credit is not all gloomy. One bright spot is Asia, where yield spreads on US dollar-denominated investment grade bonds are attractive relative to US and European similarly rated issues.
“Among China offshore bonds, we like high quality property, the large banks and well-managed state-owned enterprises,” said Tiansi Wang, senior credit analyst at Robeco, who was at the meeting.
She also sees value in investment grade issues from Indian companies that derive their revenues from domestic demand, and is sanguine about Indonesia post the reelection of president Joko Widodo.
However, Wang recommends staying clear of Asian emerging market local currency debt, because the positive [interest rate] carry doesn’t compensate for likely foreign exchange volatility.
Basically, Robeco has a high quality bias, prefers companies that are domestic consumer oriented and selected financials (in Europe), and is shunning energy-related issues and companies with a growth-tag in the communications and technology sectors.
Robeco’s strategy also applies a screening process to select issuers that contribute to realising the UN Sustainable Development Goals (SDGs) goals. The methodology assesses the SDG contribution of companies it invests in and excludes companies that contribute negatively to these goals.
Robeco SAM Global SDG Credits Fund since launch vs benchmark and sector average