04 May 2020
Fund Manager, Fixed Income
Harry Richards, Fund Manager, explains why investment grade offers abundant opportunities in a credit picker’s market.
Against broader risk assets, investment grade credit outperformed during the both brutal sell-off in March and in the subsequent rebound in risk sentiment. The asset class has been a major beneficiary of the aggressive easing measures thrown at the crisis by central banks and governments. In combination, these monetary and fiscal efforts have calmed the immediate market panic.
Market sentiment is now caught in a tug-of-war between unprecedented easing measures and deteriorating fundamentals. During risk-on phases, markets will focus on the vast scale of support provided by governments and central banks and will be prepared to ignore near-term weakness in corporate earnings and economic data. During risk-off phases we will see asset prices fall sharply as investors turn their attention to the virus and resultant lockdown conditions that are ransacking the global economy.
The ‘RoRo’ (risk-on/risk-off) dynamic is likely to continue for some time, and investment grade credit is well placed to navigate through this sort of turbulence. Firstly, we like the risk-reward that this part of the market presents. Spreads are attractive, which provides the potential for strong returns as the recovery process unfolds, but the default risk is far lower than in high yield markets where the insolvency phase of the crisis is already starting to take hold. Equally, if an investment grade issuer (rated as BBB and higher) does run into difficulty in this environment, they still have access to the credit markets and can secure additional funding to weather the storm – in our opinion, the same cannot be said for certain parts of the high yield market. While most corporates will end 2020 with worse fundamentals than when the year began, the forward-looking focus will be on managing through the downturn and protecting their credit profiles. Ultimately this means a shift towards more creditor friendly behaviour and we are already starting to see this via widespread dividend cuts and the cancellation of share buyback programmes.
Secondly, the twin support from both governments and central banks is substantial. The extensive government easing is focused on supporting the large, systemic corporates found in the investment grade market. It is vital policymakers are successful in this effort in order to avoid the unemployment data falling into a more vicious tailspin, hitting consumption and dragging out the recovery process even further. Central banks are also purchasing large quantities of investment grade corporate bonds, which should help to underpin this part of the market somewhat if sentiment deteriorates and we slip into a risk-off phase once more.
Finally, the global hunt for yield remains relentless at a time when dividend yields are falling sharply. Asset allocators are likely to see attractive qualities in investment grade credit as it continues to offer predictable income during these uncertain times.
In short, this will be a credit pickers market, with significant opportunities to add alpha by capturing the strong returns that can be generated from attractive spread levels while avoiding downgrade candidates and defaults. In the fixed income strategy at Jupiter, we continue to exploit market setbacks to buy quality investment grade bonds at stressed valuations.
Investment grade is well placed in the current crisis