Corporate bonds, here the sectors to watch
In the bond market, with negative interest rate from government bonds investments, one way to increase credit risk is to switch into corporate bonds or high yield bonds. Which are the sectors to keep monitored?
In the bond market, with government bonds that are showing a negative rate, one way to increase credit risk is to switch into corporate bonds or high yield (HY) bonds.
Corporate bonds are currently not in the Quantitative Easing (QE) purchasing list, but they also benefit from the interest rate rally. In addition, they offer extra credit spread which should provide some cushion for when interest rates are moving higher again. “The QE programme is having a knock-on effect on riskier assets, like investment grade corporates and high yield for example, as investors are pushed into riskier assets in order to grab additional yield or simply avoid negative yields”, Fabrizio Palmucci, Executive Director, Fixed Income Specialist of Source, said.
As of end of February 2015, JP Morgan estimates that EUR 1.6 trillion of European sovereign bonds were yielding negatively. “As an illustration of the chase for yield, according to JP Morgan, as of end of February, the European HY asset class registered year to date EUR 3.7 billion of fund flows, this represents 6.3% of HY fund Asset under management, while February was one of the strongest months since 2011”, Palmucci added.
It is likely that riskier assets will in the short-run outperform risk-free assets as investors are chasing yields. This is a technical effect (supply/demand) supported by QE. “However, longer-term investors need to think about the other two factors, such as valuations and fundamentals – Palmucci explained – Valuations for riskier assets like Investment Grade (IG) corporate look attractive compared to the risk-free rate; however, less so if you compare European IG spreads versus the US IG”.
According to Viktor Nossek, Head of research of WisdomTree Europe, large corporates are the new safe havens because they have strong balance sheets, they are less bank finance dependent and less exposed to bank systemic risks, and have no wage pressures (unlike the US), and easy access to bond markets. “They also offer a slight yield premium over government bonds, even though large corporates should be viewed as near risk-free today, based on the 3 points mentioned above”, he said.
“Investors might consider buying companies that are likely to merge to strengthen their balance sheets, leading to an upgrade from high yield to investment grade. As well as merger and acquisition-led opportunities, we believe there are also companies that have recently been upgraded that will eventually form part of the investment-grade universe”, Salman Ahmed, Global Strategist of Lombard Odier IM, declared.
Which are the sectors to watch?
“We see a lot of first time issuers across a wide area of sectors as companies continue to diversify their funding needs away from banks. The Technology, Media, Telecommunications (TMT) and healthcare sectors are currently experiencing the largest M&A activity”, Tatjana Greil Castro, portfolio manager of Muzinich, declared. She also sees lots of regional utilities which are owned by local municipalities come to the European corporate bond market: “these are usually mature businesses which in the past were fully bank funded. Whilst some of the excess capacity in the paper sector has already been retired, the sector continues its structural decline – Tatjana Greil Castro added – Retail has always been an extremely competitive sector and so one usually needs to select very carefully in that sector. Gaming is under close regulatory scrutiny and can easily be the subject of higher taxation to the extent that government need to bolster their income”.
At last, “cheaper cyclicals should do better than expensive defensives, especially if first indications of a recovery in Eurozone’s domestic economy prove to have legs, such as rising loan growth over the last three months”, Viktor Nossek, Head of research di WisdomTree Europe, concluded.