Jenna Barnard, Co-Head of Strategic Fixed Income, explains why she believes the second quarter of 2020 has been an idyllic environment for corporate bond investing.

 Key takeaways: 

• Cheap valuations, very low government bond volatility and a realisation that company defaults would not be as high as originally anticipated, helped make the last three months an idyllic environment for corporate bond investing.
• This confluence of factors is driving credit performance, even in the face of an onslaught of new issue supply and will likely continue into the third quarter.
• We believe ‘sensible’ corporate bonds are the place to be and find government bonds and duration much less interesting than we have for a number of years. As we see it, divergence opportunities across the developed world are now coming through much more strongly in the credit markets.

Video transcript

 

Hi. This is Jenna Barnard providing you with a second quarter update.

An idyllic environment for corporate bond investing

I think the first thing to say is that it’s been an absolutely idyllic environment for corporate bond investing over the last three months. Probably one of the best periods for credit investing in decades and that reflects a number of factors. Very cheap valuations, as we came into the second quarter;  very low government bond volatility, which is driving a search for income in other asset classes, and thirdly, I think a growing realisation that default rates are not going to be as high as people thought a few months ago.

And that’s particularly the case in Europe where huge government support for corporations and a lack of commodity exposure means that European high yield default rates are looking like they’ll be as low as 4 or 5 percent this year. I mean, that’s in line with the long‑term historic average, nowhere near the kind of recessionary peaks of 12 to 14 percent that high yield investors in both the US and Europe are used to seeing.

And so, this confluence of factors is driving credit performance, even in the face of an onslaught of supply, of new bonds being issued. And frankly the [US Federal Reserve’s] Fed’s mediocre and underwhelming purchases of corporate bonds are not the primary factor. It’s that backdrop that I just talked you through, which we think is likely to continue as we head into the third quarter of 2020.

Looking for opportunities while avoiding zombie sectors

That being said you obviously want to avoid the value sectors or the troubled zombie sectors where defaults are concentrated but they’re very obvious areas like traditional retail, energy – business models that were already being disrupted by technology and that’s now accelerating. And as an active manager frankly those are easy to avoid. So, we think sensible corporate bonds is the place to be in this environment of Japanification that’s been accelerated by the Covid crisis.

Government bond yields are relatively uninspiring; every central bank in the developed world has cut rates to zero. They’re all engaging in quantitative easing and it’s very hard to find any relative value opportunities in government bonds today. It is also the case that government bonds appear to have been anaesthetised. They’re not reacting to the much improved rate of change in the economic data in the last few months. And there seems to be just a very, I think, complacent attitude towards government bonds that central banks have capped yields, which they haven’t explicitly but the market seems to believe they have.

So that’s to say that we find government bonds and duration much less interesting than we have for a number of years. We are still finding divergence opportunities across the developed world. That’s now coming through much more strongly in the credit market, and I talked you through that difference in default rates between the US and Europe as one example.

Thank you.

 

Notes:

Zombie companies: companies that are struggling to exist, typically heavily indebted so that most of their cash generation is used to service their debts.

Japanification: the weak growth and persistently low inflation environment that has characterised Japan since the 1990s despite huge levels of policy support by the central bank and the government.