Monday, November 4, 2024
Monday, November 4, 2024
Home » The Time is Right for Investment Grade Credit

The Time is Right for Investment Grade Credit

by Camren Potter
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Global investment grade bonds are back, with quality issuers offering opportunities for investors to diversify portfolios and realise the potential for attractive returns.

After last year’s sweeping sell-off, analysis of corporate fundamentals is returning to centrestage and investment grade bonds are set to resume their historical position as resilient and reliable options during volatile and uncertain market conditions.

Signs that investment grade credit is heading into a “sweet spot” are supported by increased inflows from investors who were underweight the high-grade bond asset class for years due to low yields.

Here, I outline six reasons why investment grade bonds present a significant opportunity for investors at this point of the cycle.

Most attractive pricing in years

The cash price of investment grade bonds fell to approximately 85 (par-weighted price on the Global Corporate Index) in mid-2022, falling close to levels only seen during the Global Financial Crisis (GFC). Par-weighted price weighs the price of each bond by its relative size in the index. It indicates whether the index is generally selling at prices above or below face value, which can influence interest rate sensitivity.

Today, prices are at approximately 91, which is the most attractive level we have seen in years. Because of this, convexity concerns have all but disappeared and expectations are high for healthy levels of income going forward.

Yields at decade highs

Yields are looking very attractive. For the global investment grade market, they are at almost 5 per cent, which is historically the highest level seen for these assets, especially over the past decade. This indicates that a moderate recession and even some systemic stresses have been priced in.

This presents a positive outlook for future returns. Past experience demonstrates that assessing the yield offered at different points in history, and the subsequent return after a five-year period, yield level is a reliable predictor of future returns.

Duration presents opportunities

With indications that central banks are nearing the end of their current interest rate hiking cycles, duration exposure is of particular importance today. With an effective duration of approximately six years, and assuming inflation will halve over the next two years, investors can anticipate potentially significant and positive returns from the global investment grade market.

Diversification at multiple levels

The approximate US$12 trillion global investment grade market offers significant diversification among its 18,000 issuers. The opportunity set expands across 62 countries to well-diversified sectors and within large capital structures of corporations.

By providing exposure to both spreads and interest rates, the global investment grade market provides an additional element of diversification since spreads and rates tend to move in opposite directions.

Fundamentals are strong

Positioning within larger, higher-quality companies that issue liquid bonds will be of paramount importance, as analysis of corporate fundamentals returns to centrestage and tighter credit conditions stress the lower-quality parts of credit markets. Larger, higher-quality bond issues will be better positioned to weather the market conditions that typically follow slower economic growth.

Overall, fundamentals within the global investment market are strong. Balance sheets look very healthy as companies have accumulated cash over the past couple of years (indicatively, European corporate bank deposits reached €3.5 trillion at FY 2022, up 36 per cent from pre-pandemic levels). Leverage is at historically low levels for European corporates, despite ticking up slightly during Q4 2022, but only after nine consecutive quarters of being reduced. Interest coverage is at historically high levels and debt growth has sat at around zero since the middle of 2021. Strong fundamentals across credit markets have resulted in persistently low levels of defaults both in the US and Europe.

Opportunities in sustainable investments

The global investment grade market provides not only opportunities for superior risk-adjusted returns, but importantly opportunities to invest in various forms of sustainability. This includes “labelled bonds” such as green, social, and transition bonds, and sustainable leaders – companies at the vanguard of their respective sectors who see value creation in protecting the planet and providing sustainable products and services.

Source : InvestorDaily

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