In 2019, with global investment grade corporate bond yields around 2.5%, our Head of Fixed Income, David McLeish, wrote an open ‘Dear John’ letter to the market – setting out why the investment team had decided to go underweight the asset class. Today, with yields close to topping 6%, the highest in more than a decade, the investment team looks to be falling back in love.
We can’t stop thinking about the global corporate bond market
I know it’s sad. But it’s true.
The recent rare bout of high global inflation set alongside slowing economic activity has been disastrous for the recent performance of global corporate bonds – a usually stable earner. As a result, this major global asset class is now offering the most attractive valuations we have seen since the Global Financial Crisis.
But rather than having to anticipate exactly when corporate bond prices will reverse course, the now high interest income generated by these assets means it is one where investors are being paid handsomely to wait.
The grief-case has been unpacked. It is time to move on
The emotional baggage accumulated from witnessing a bond sell-off as brutal as the one we’ve just had can be hard to shake. But having invested through many market cycles we know that investing success only comes to those who can hold a steady hand, stay focused on the big picture, and maintain a long-term perspective – as that is what it takes to act when the big opportunities arise.
Stepping back from all the market speculation about unanchored inflation and worries of a sharp economic downturn ahead, we see bonds as an unloved asset class with a reliable and now plentiful income stream on offer.
In the past, when yields have been this high, extraordinary returns can follow
Over the past 40 years, when yielding the same as they do today, US investment grade bonds have on average generated an almost 7% return over the following twelve months. What’s more, from this starting point, returns have been +20% on more occasions than they have been negative.
When we see an attractive set up like this, our hearts start to flutter.
The pandemic has helped companies prepare for what lies ahead
Corporate profitability is likely to turn lower next year, as the full impact of recent interest rate hikes take hold. This will, no doubt, be an insurmountable challenge to some businesses with too much debt and/or rigid and high fixed cost bases.
But this is not unusual, and unlike prior crises, we don’t see any obvious large, systemic fragilities in the financial system this time around. In fact, quite the opposite, with the banking system in possibly the best shape we have seen in decades.
What’s more, the widespread disruption caused by the pandemic has helped companies prepare for a downturn, should it happen. Most corporate and household balance sheets are in good order, a very high proportion of the population are gainfully employed, and a meaningful savings pool remains in place to help soften the blow.
Careful investment selection remains imperative
We know from experience that, in times of heightened uncertainty, finding a bond with a high yield isn’t the hard bit. It is finding attractively priced bonds issued by companies that will weather an economic downturn if one is thrown at them.
That is why we have a team of experts trained to thoroughly analyse businesses from the bottom-up on your behalf. Our approach is simple – don’t lose sight of the big picture, trust our investment process, and act with conviction when opportunities like this present themselves.
This really could be a match made in heaven.
