Investors are closely watching bond spreads as corporate valuations soar amid competition for assets
New York: Corporate-bond valuations are hitting record highs, and it’s raising some eyebrows. With a flood of cash from pension funds and insurers, competition for these assets is fierce. But surprisingly, many investors aren’t too worried about the risks involved.
Some money managers think these high valuations might stick around for a while. The spreads, which are the extra costs of buying corporate bonds over safer government ones, could stay low for longer. This is partly because some government debts are looking less appealing due to fiscal deficits.
Christian Hantel, a portfolio manager, pointed out that history shows there have been times when spreads remained tight for extended periods. Right now, we seem to be in one of those phases.
While some investors are concerned about high valuations, they’re also attracted to the yields, which seem pretty good compared to the last couple of decades. They’re not too focused on how these yields stack up against government bonds. Some even believe there’s still room for spreads to tighten further.
According to Matt Brill from Invesco, spreads on US high-grade corporate bonds could drop to 55 basis points. They were at 80 basis points recently, and Europe and Asia are also nearing their lowest levels in years.
Hantel mentioned that factors like improved bond quality and a more diverse market are keeping spreads tight. For instance, BB-rated bonds are now more common in global junk indexes, and the number of BBB bonds in high-grade trackers has been decreasing, which used to be a big worry.
Investors are also looking at the carry, which is the money they make from coupon payments after covering any costs. Mohammed Kazmi from Union Bancaire Privee noted that you don’t need much in spreads to get close to double-digit returns in high yield. It’s mostly about the carry, and even if spreads widen, the overall yield provides a cushion.
Interestingly, tighter spreads mean that the cost of protecting against defaults is at a low point. Fund managers have used similar cheap periods in the past to build up insurance, but right now, there hasn’t been enough buying pressure to raise credit default swap risk premiums.
However, the narrowing spreads have made it harder to differentiate between stronger and weaker issuers. Bond buyers are getting less compensation for taking on extra risk, and companies with shaky finances aren’t paying much more than their stable counterparts.
It would take a significant change in the market to alter risk premiums. Gurpreet Garewal from Goldman Sachs believes that a mix of worsening fundamentals and weakening market dynamics would be necessary to shift the credit cycle, which isn’t expected in the near future.
In recent news, several blue-chip firms raised a whopping $15.1 billion in the US investment-grade market, gearing up for a busy January for bond sales. Meanwhile, some companies are facing challenges, like The Container Store filing for bankruptcy due to losses and debt issues.
Overall, the bond market is buzzing with activity, and it’ll be interesting to see how things unfold in the coming months.
