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World’s Safest Company Bonds Have Worst Start to Year in Decades

World’s Safest Company Bonds Have Worst Start to Year in Decades

The safest corporate bonds in the world are having their worst start to the year in just over two decades as investors brace for tighter monetary policies.

A global index of investment-grade company debt has posted total return losses of 2.2% since the start of the year, the most since data going back to 2000. The gauge is faring worse than all others in the category of credit securities outside of emerging markets. 

With yields rising to levels last seen before the pandemic on Treasuries and German bunds, investment-grade bonds look vulnerable to rate hikes and could attract more defensive bets. Those borrowers typically issue notes with longer maturities, and their greater duration -- a measure of price sensitivity to rate moves -- spurs steeper drops as yields climb.

Investment-grade bonds are where the trouble starts “when you go from a bull market to something more bearish,” Viktor Hjort, global head of credit strategy at BNP Paribas SA, said in an interview. “As we reach some of the inflection points in the market cycle, the IG corporate bond market will be hit first.”

World’s Safest Company Bonds Have Worst Start to Year in Decades

Other market dynamics are adding to the pressure. BNP Paribas’s Hjort anticipates a jump in bond issuance this year as companies need to invest in infrastructure and supply centers, among other projects. At the other end, demand from central banks may ease, especially as the European Central Bank prepares to wind down its pandemic bond-buying program in March. This supply-demand imbalance can boost risk premiums.

Investors are taking note. Pacific Investment Management Co. is reducing the share of corporate bonds in its credit portfolios, even though it’s overweight in the credit market, according to a recent cyclical outlook. Instead, it’s looking at credit-default swaps and structured credit, such as non-agency mortgage-backed securities, according to Eve Tournier, credit portfolio manager. 

“As well as offering diversification, these can improve the convexity of our portfolios through their defensive qualities,” she said in an interview, referring to a measure of interest-rate risk.

Indeed, baskets of credit-default swaps -- contracts that provide insurance against corporate defaults -- have been much more resilient this year. Both in North America and Europe, total return losses for investment-grade CDS indexes this year are a fraction of bond returns.

World’s Safest Company Bonds Have Worst Start to Year in Decades
A Little Extra Detail:
Due to investment-grade bonds’ higher duration, the average security would drop 7.2% in price when yields climb 100 basis points, compared to a 4% drop for junk debt, based on Bloomberg indexes.

“Yields are going to go a little bit higher before things start to stabilize,” said Winnie Cisar, global head of strategy at CreditSights. “For retail investors right now, it’s hard to see those total return losses and kind of stick with the trades.”

Institutional investors with a longer-duration yield mandate may be attracted to all-in yields on U.S. investment-grade credit of 3%, according to Cisar. The yield to worst on Bloomberg’s high-grade index jumped as high as 2.72% this week, from 2.33% at the start of the year. 

For some, the selloff in investment-grade may already offer buying opportunities.

The rout in some sectors “looks a bit extreme,” said Nachu Chockalingam, a senior credit portfolio manager at Federated Hermes, which oversees 466.8 billion pounds ($636 billion). Financial issuers should benefit from the move in rates, and some borrowers’ yield curves seem too steep after 10-year securities underperformed intermediate maturities, she added.

She concurs, however, that the high-grade slump can be justified by spike in government yields and increased supply of bonds. And with inflation readings surprising to the upside, bets for faster, sooner policy tightening are growing in the developed world.

“We see turbulence in spreads as higher rates inflict pain in general risk sentiment through the equity market like a repeat of end-2018” said Shanawaz Bhimji, senior fixed-income strategist at ABN Amro NV.

Elsewhere in credit markets:

Americas

In another step forward for a new benchmark lending rate, KKR & Co. switched to the regulator-approved Secured Overnight Financing Rate from Libor in the middle of marketing a buyout financing on behalf of Trilantic North America.

  • MidOcean Partners has hired Jamil Nathoo, a veteran of Goldman Sachs Group Inc. and BNP Paribas SA, to increase its collateralized loan obligations business
  • Mudrick Capital Management’s $600 million stressed credit fund gained 21% in 2021 following its absorption of a CVC Credit Partners fund that invested in troubled companies and other debt, according to a person with knowledge of the returns
  • For deal updates, click here for the New Issue Monitor
  • For more, click here for the Credit Daybook Americas

EMEA

Europe’s primary bond market is set to see weekly issuance surpass 50 billion euros ($56.7 billion) after a hectic flow of sales early in the week.

  • The first month of the year already saw more than 191 billion euros of issuance, closing in on the highest January record of 239 billion euros in 2020
  • The financial sector is set to wrap up the week with mandates from Erste Bank Hungary and National Bank of Canada
  • Meanwhile, banks are preparing a $10 billion financing comprising bonds and loans to back the leveraged buyout of cybersecurity software maker McAfee Corp., according to people with knowledge of the transaction
  • Bank of Montreal sold a 2.75 billion euro bond on Wednesday, the largest single-tranche publicly syndicated EUR denominated covered bond since 2006

Asia

Chinese developer Greentown China Holdings is kicking off a sale of “credit enhanced” green dollar bonds, which will be a key test of appetite for the embattled real estate sector.

  • China Aoyuan Group Ltd. became the nation’s latest developer to succumb to the liquidity crisis in the industry, saying it won’t make payments on four dollar bonds, which will trigger defaults on all other offshore debt
  • Japanese steel producer JFE Holdings plans to sell about 30 billion yen of transition bonds in the new fiscal year starting in April
  • Also from Japan, SoftBank Group Corp. priced a 550 billion yen bond on Thursday, its biggest-ever yen sale, to pay off other debt

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