Investment grade corporate bond valuations look a bit stretched, and don’t really reflect company fundamentals. However, as long as central banks are still there to deploy monetary stimulus, the risk of material spread widening is limited, says Peter Becker, Fixed Income Investment Director at Capital Group.
Looking ahead, in an environment where valuations on an overall index level remain clearly stretched, idiosyncratic credit risk selection becomes more important. In some areas of the market, dispersion is high relative to its history and finding attractive opportunities requires deep fundamental research.
There is a significant number of bonds on the edge of being downgraded to sub-investment grade. Selecting those that will remain investment grade will be key for success in corporate bonds investing this year.
On an aggregate level, we are close to neutral on credit risk, but we still see opportunities in sectors where some names may have further room to tighten, like energy, chemicals and technology. We are underweight in sectors where we find fewer opportunities such as communications, consumer goods and financials. In these sectors, it’s very important to do your homework.
What happened in the investment grade bond asset class in 2020 was unique. In one year, we experienced a credit cycle that can typically last six to ten years. In March, the global corporate spread widened from below 100 basis points to more than 300 basis points, and then subsequently went back to 100 basis points within nine months – which is where we are now. The recovery began after central banks intervened in March and April to give markets a confidence boost. Now we’re at credit levels fully valued given weaker corporate fundamentals.
The huge volume of new issuance was sustained at a record level for a few months last year, right after support from central banks. Given the uncertainty of the outlook, companies used this monetary support to bring forward their financing. This offered attractive opportunities, with new issue concessions of up to 100 basis points.
Being defensively positioned at the start of the sell-off, we had some dry powder or cash to increase our risk position, with attractive household names that were previously too expensive cheapening up and issuing new debt. Nonetheless, with our 15 investment grade analysts benefitting from our large network of 170 plus equity analysts, we remain selective, fully utilising our unique position to speak to individual companies and fully understand their proposition.