There has been an unprecedented rise in the value of negative-yielding assets this year. The share of global assets that are negative yielding rose to an all-time high of 29% in August and now stands at just above 20% – still a hefty proportion of the fixed-income universe.
In this turn, this means that 2019 has become the first year in the modern history of credit markets where global investment-grade returns match those of high yield. Figure 1 shows how 2019 is the only year of double-digit returns where global investment-grade and high-yield markets have performed in line.
Figure 1: Investment grade returns on par with high yield
Source: Herme Credit, ICE bond indices, as at December 2019.
The difficult macroeconomic environment, a pick-up in defaults and low sovereign yields have prompted asset allocators to look to corporate credit this year, as investors that target high returns now need to choose which type of extra risk they are willing to take on. Initially, some managers extended duration and moved into lower-quality sovereign instrument. The next logical step was then to increase allocation to corporate credit – starting with investment grade.
Other options included taking on more foreign-exchange risk – by moving into higher-yielding currencies unhedged – or seeking a greater illiquidity premium in other asset classes. But this would likely have been a larger deviation from existing mandates then moving into corporate credit.
Looking into 2020, demand for credit should remain solid. Yet to deliver strong returns going forward, investors will need to take an unconstrained approach and focus on high-active share investing. At Hermes, we believe that flexible strategies are able to generate returns by allocating capital and risk across the entire credit spectrum and throughout the capital structure, something we discuss in more detail in our piece on flexible allocation.