(Bloomberg) — Corporate bond valuations are in desperate territory, issuing their biggest warning in nearly 30 years as an influx of money from pension fund managers and insurers increases competition for the assets. So far, investors are optimistic about the risk.
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Many money managers don’t see valuations coming back to Earth anytime soon. Spreads, the premium for buying corporate debt rather than safer government bonds, may remain low for an extended period, in part because fiscal deficits have made some sovereign debt less attractive.
“You could easily say that spreads are too tight and you need to go elsewhere, but that’s only part of the story,” said Christian Hantel, portfolio manager at Vontobel. “When you look at history, there are a couple of periods where spreads stayed tight for quite a while. “We are in that regime right now.”
For some money managers, high valuations are cause for alarm, and there are now risks, including inflation weighing on corporate profits. But investors who buy the securities are attracted by yields that appear high by the standards of the last two decades and are less focused on comparing them with government debt. Some even see room for further compression.
Spreads on high-quality U.S. corporate bonds could narrow to 55 basis points, Invesco senior portfolio manager Matt Brill said at a Bloomberg Intelligence credit outlook conference in December. On Friday they were indicated at 80 basis points or 0.80 percentage points. Europe and Asia are also approaching their lowest levels in decades.
Hantel cited factors including shortening index duration and improving quality, the tendency for the price of discounted bonds to rise as they approach payment, and a more diversified market as trends that will keep spreads tight. .
Take BB-rated bonds, for example, which have more in common with blue-chip corporate debt than highly speculative bonds. They are close to their highest share in global garbage indices. Additionally, the percentage of BBB bonds in highly rated trackers (a major source of anxiety in previous years due to their high risk of downgrade to junk) has been declining for more than two years.
Investors are also focusing on carry, industry jargon for the money bondholders make on coupon payments after any leverage costs.
“You don’t necessarily need a lot of spreads to get close to double-digit returns” in high yield, said Mohammed Kazmi, portfolio manager and chief fixed income strategist at Union Bancaire Privee. “It’s mainly a carry story. And even if you see wider spreads, you have the margin of total return.”
Tighter spreads also mean that since the financial crisis, the cost of protection against defaults – or at least the price of hedging market volatility – has rarely been as low as current levels. Fund managers have taken advantage of similar low-cost periods in the past to create insurance, but so far there hasn’t been enough buying pressure to push up risk premiums for credit default swaps.
The overall rebound in spreads has undoubtedly narrowed the gap between the strongest and weakest issuers in the credit market. Bond buyers are paid less to take on additional risk, while companies with fragile balance sheets don’t pay much more than their stronger peers when they raise money.
Still, a significant shift in momentum will be needed to alter risk premiums.
“While fixed income spreads are tight, we believe a combination of deteriorating fundamentals and technical dynamics would be necessary to trigger a turn in the credit cycle, which is not our base case for next year,” he said. Gurpreet Garewal, macro strategist and co-head of public markets investment insights at Goldman Sachs Asset Management.
Two weeks in review
A host of blue-chip companies raised a total of $15.1 billion in the U.S. investment-grade primary debt market on Jan. 2, as underwriters prepare for what is expected to be one of the busiest Januarys. for bond sales. Another billion dollars in sales occurred on Friday, January 3rd.
Apollo Global Management Inc. and other financial heavyweights won a key lawsuit, effectively voiding a financial transaction from which they had been excluded for Serta Simmons Beding, a company whose debt they held. Serta had allowed a handful of investors to provide $200 million to the company in exchange for moving up the line if the bed maker failed. The decision may raise questions about whether other “upgrading” transactions will be allowed to take place.
The Container Store Group Inc. filed for bankruptcy to deal with mounting losses and a significant debt load that has weighed on the chain.
Bankrupt retailer Big Lots Inc. won court approval of a bailout deal to prevent some of its stores from closing despite challenges from suppliers who said the deal unfairly imposes large losses on them.
IHeartMedia Inc. said it completed an offer to exchange some of its debt, extending maturities and reducing principal, in a move S&P called “tantamount to a default.”
Carvana Co., an online used car seller that has borrowed in the ABS and junk bond markets, was accused by prominent short seller Hindenburg Research of wrongdoing in a report alleging that the high-value loan portfolio The company’s risk carries substantial risk and its growth is unsustainable.
Healthcare analytics company MultiPlan Corp. has reached an agreement with most of its creditors to extend the maturities of its existing debt.
Glosslab LLC, a New York City-based nail salon chain that experimented with a membership-based business model and attracted celebrity investors, has filed for bankruptcy.
Aerospace supplier Incora has been granted court permission to emerge from bankruptcy after announcing that its major creditors have agreed to support a restructuring after years of acrimony over an infamous financial maneuver that pitted lenders against each other.
Municipal bonds sold by universities and charter schools took a hit to record levels in 2024, when the amount of state and local government debt in default hit a three-year high.
On the move
Goldman Sachs Group named Alex Golten chief risk officer. Golten, earlier in his career, was the company’s director of credit risk.
Morgan Stanley Direct Lending Fund has appointed Michael Occi as President, effective January 1, 2025.
Kommuninvest has appointed Tobias Landstrom as new head of debt management.
