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Putting the ‘investment’ in investment grade credit

30 May 2023 |
Investment grade bonds have historically provided a resilient and reliable option during volatile and uncertain market conditions. After last year’s sweeping sell-off, the global investment grade universe now offers an array of opportunities in quality issuers, allowing for effective diversification and the potential for attractive returns.

Why now?

Yields are at decade highs: Yields, which sit at almost 5% for the global investment grade market, are looking very attractive. Historically, and looking at the past decade in particular, yields are now at the highest level seen for the investment grade market, as demonstrated in Figure 1 below. This indicates that a moderate recession and even some systemic stresses have been priced in.

Figure 1: Yield levels at decade highs

So, what does this mean for future returns? By assessing the yield offered at different points in history and the subsequent return after a five-year period, evidence indicates yield level is a reliable predictor of future returns.1

Figure 2: Investment grade yields and returns after five years

Prices at most attractive level in years: The cash price of investment grade bonds fell to approximately 85 (par-weighted price on the Global Corporate Index) in mid-2022, and fell 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 continues to be 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.

Figure 3: Global Corporate Index price level

Duration: Duration exposure is of particular importance today, as recent macro forecasts indicate that central banks are nearing the end of their current hiking cycles. With an effective duration of approximately six years, and assuming inflation will halve over the next two years, investors are looking at potentially significant and positive returns from participating in the global investment grade market.

Diversification at multiple levels: The approximate US$12tn global investment grade market offers significant diversification among its 18,000 issuers1. The opportunity set expands across 62 countries to well-diversified sectors and within a large capital structures of corporations.

Figure 4: Global Corporate Index country diversification

Figure 5: Global Corporate Index sector diversification

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 to one another.

Figure 6: Global IG option-adjusted spread and five-year treasury yield

Fundamentals are back: Unlike last year, where markets were driven by central bank action and the overall interest rate environment, 2023 is a year where analysis of corporate fundamentals is taking centre stage once again, as tighter credit conditions are causing stresses to appear in the lower-quality parts of credit markets. Positioning within larger, higher-quality companies that issue liquid bonds will be of paramount importance as they are better positioned to weather the market conditions that typically follow slower economic growth.

Overall, fundamentals within the global investment market remain strong. Balance sheets look very healthy as companies have accumulated cash over the past couple of years (indicatively, European corporate bank deposits reached €3.5tn at FY 2022, up 36% from pre-pandemic levels2). 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 can be seen across credit markets, which resulted in persistently low levels of defaults both in the US and Europe.

Figure 7: Net leverage and total debt growth

Figure 8: Interest coverage

Technicals bode well for the asset class: Investment grade technicals remain supportive as supply has been light in the first four months of the year compared to the same periods over the past three years. On average, we saw supply of $571bn over the last three years compared to $463bn year-to-date.3  

In addition, the expression ‘fixed income is back’ has been supported by inflows into the high-grade bond market by investors who were underweight the asset class for years due to low yields.

Figure 9: Supply from January to April

Sustainability: 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.  

1 Past performance is not a reliable indicator of future performance.

2 JP Morgan, as at May 2023.

3 JP Morgan, as at December 2022.

4 JP Morgan, as at May 2023.

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