(Bloomberg) — Corporate bond valuations are hemorrhaging, posing the biggest warning in nearly 30 years as an influx of cash from pension fund managers and insurers strengthens competition for assets. So far, investors are optimistic about the risks.
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Many money managers don’t see valuations coming back down to earth anytime soon. Spreads, the premium for buying corporate debt over safer government bonds, may remain low for longer, in part because fiscal deficits have made some government debt less attractive.
“You could easily make a call that the 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 several periods when spreads were tight for quite a long time. We are in such a regime at the moment.”
For some money managers, high valuations are a cause for concern, and now there are risks, including inflation weighing on corporate profits. But investors buying securities are drawn to yields that look high by the standards of the past two decades, and less focused on how they compare to government debt. Some even see room for further contraction.
Marches on U.S. high-quality corporate bonds could ease to 55 basis points, Invesco senior portfolio manager Matt Brill said at the 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 nearing their lowest levels in decades.
Hantel cited factors including reduced index duration and improving quality, the tendency for discounted bond prices to rise as they approach maturity and a more diversified market as trends that will keep margins low.
Take BB-rated bonds, which have more in common with blue-chip debt than highly speculative bonds. They are close to their largest share ever in the global junk indices. In addition, the percentage of BBB bonds in high-quality trackers — a major source of concern in previous years because of their increased risk of being downgraded to junk — has been declining for more than two years.
Investors are also focusing on “carry,” industry parlance for the money bondholders earn from coupon payments after any leverage costs.
“You don’t necessarily need a lot of spread 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 mostly a transmission story. And even if you see wider spreads, you have a buffer of all-in returns.”
The tighter margins also mean that since the financial crisis, the cost of protecting defaults – or at least the cost of protecting against market volatility – has rarely been as low as current levels. Fund managers have taken advantage of similar periods of cheapness in the past to build insurance, but so far there hasn’t been enough buying pressure to drive premiums for credit default swaps higher.
Truth be told, the growing spread has narrowed the gap between stronger and weaker issuers in the credit market. Bond buyers are paid less for taking on the extra risk, while companies with fragile balance sheets don’t pay much more than their more solid counterparts when they raise money.
However, a significant shift in momentum will be required to increase risk premia.
“While the differences in fixed income are small, we believe it would take a combination of deteriorating fundamentals and weakening technical dynamics to trigger a turnaround in the credit cycle, which is not our base case for the coming year,” said Gurpreet Garewal, macro strategist and co-head of the department. for investing in public markets 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 insurers brace for what is expected to be one of the busiest Januarys for bond sales. Another billion dollar sale occurred on Friday, January 3rd.
Apollo Global Management Inc. and other financial heavyweights won a key lawsuit, effectively reversing a financial transaction they were excluded from for Serta Simmons Bedding, the company whose debt they held. Serta allowed a handful of investors to give $200 million to the company in exchange for advancements in the line that will be returned if the bed maker fails. The decision could raise questions about whether to allow other “augmenting” transactions.
Container Store Group Inc. it filed for bankruptcy to deal with the mounting losses and heavy debt burdening the chain.
The bankrupt shopping chain Big Lots Inc. won court approval for a rescue deal to save some of its stores from closing despite challenges from suppliers who argued the deal unfairly burdened them with heavy losses.
iHeartMedia Inc. said it had completed an exchange offer for some of its debt, extending maturities and reducing principal, a move which S&P said was “tantamount to default”.
Carvana Co., an online used car retailer that borrowed in the junk bond and ABS markets, was accused by prominent short seller Hindenburg Research of impropriety in a report that said the company’s subprime loan portfolio carried significant risk and that its growth unsustainable.
Healthcare analytics company MultiPlan Corp. reached an agreement with most of its creditors to extend the maturity of the existing debt.
Glosslab LLC, the New York-based nail salon chain that experimented with a membership-based business model and attracted celebrity investors, has filed for bankruptcy.
Aircraft supplier Incora won court permission to emerge from bankruptcy after it announced its biggest creditors had agreed to back a restructuring after years of acrimony over a notorious financing maneuver that pitted lenders against each other.
Municipal bonds sold by colleges and charter schools fell to record levels in 2024, as the amount of state and local government debt in default hit a three-year high.
On the go
Goldman Sachs Group has appointed Alex Golten as Chief Risk Officer. Golten was the company’s chief credit risk officer earlier in his career.
Morgan Stanley Direct Lending Fund has appointed Michael Occi as President, effective January 1, 2025.
Kommuninvest has appointed Tobias Landstrom as the new Head of Debt Management.
