Corporate bonds: from reassuringly expensive to scary cheap?
John Pattullo Co-Head of Strategic Fixed Income | Portfolio Manager
John Pattullo, Co-Head of Strategic Fixed Income, shares how the Strategic Fixed Income Team continue to carry out their day to day jobs successfully, albeit from home, remaining focused on their client outcomes.
The past week has been brutal for risk assets, while traditional hedges for risk, such as US Treasuries and gold, stopped working as investors liquidated portfolios to raise cash.
The week was also marked by significant investment grade issuance, at very wide spreads, as companies sought to raise cash; and central bank actions, announcing numerous measures to calm volatility in the markets and ease liquidity conditions.
We are excited about the valuation opportunities that are surfacing. However, we continue to monitor the redemption pressure some market participants are experiencing.
This video was filmed in London on Monday morning, a few hours before the announcement of two new facilities to purchase corporate bonds by the US Federal Reserve at 8:00am New York time.
The indices whose yield and spreads were mentioned by John Pattullo are ICE Bank of America Merrill Lynch US investment grade and high yield bond indices.
Past performance is not a guide to future performance.
Good morning. John Pattullo here, speaking on Monday 23rd March. Jenna [Barnard] and I are working from home. As you can see we have been for a week or so now. The team is all functioning. We're all fine and have the systems [that we need] for trading and we're very much doing a great job. The philosophy and the process hasn't changed at all, and I'm glad to say we remain very focused on clients and client outcomes in what are frankly very tough times for all of us.
I suppose, performance wise, we weren't particularly surprised if we'd known what was going to happen to asset classes, how we've performed in the last week or so. I think relatively speaking we have held up fairly well. We've always been of the view that it is pretty late-cycle and the book on the strategic [portfolio] was reasonably well in decent assets, such as sovereigns and investment grade bonds. We do hold some investment grade of course, but quality, large-cap, non-cyclical businesses and we had a fairly modest and historically relatively low allocation to high yield and financials. So that kind of got us through if you like.
A brutal week for risk assets
It was obviously a brutal week for all risk assets and there was waves of deleveraging and forced selling by many in the market. Again, we weren't too bad at all in that regard. But what you did see is some of the traditional hedges such as [US] Treasuries and gold really stop performing as people just liquidated assets to raise cash. To give you a feel of some of the moves for example, investment grade bonds, which at the beginning of the year you had a 2.9% [yield] on a spread of 100 basis points, now have a spread of almost 400 and yield about 4.7%. High yield respectively at the beginning of the year was yielding 5.3% and now yields about 10.75% in America, spreads have ballooned from 360 to over a thousand [basis points].
Last week was actually interesting, because you saw significant investment grade issuance as some companies desperate for cash issued at frankly very wide levels. It was actually the third largest issuance week for investment grade and they paid up — just that keen for cash — which is pretty interesting. Energy and gaming and leisure obviously big underperformers in high yield, and technology actually performed very well.
Getting through peak panic?
So, extraordinary times. We actually think we're kind of getting through it. We obviously had the peak panic. I think a lot of people forget about the oil shock. The oil shock was significant a couple of Mondays ago [9 March] and obviously the pandemic is washing right across the world as we speak. And what we're seeing is a moderate, so far, but increasingly rapid response from central bankers. I mean this is wartime economics, a wartime response is justified. And the American response and the British response, and parts of Europe, have been significantly encouraging and there'll be more of it.
There've been whole acronyms of new policies and so on washing through; the Americans and [the] British are kind of leading here, and there are rumours in the market that the Americans will probably backstop the corporate bond market [that is the US Federal Reserve]. They currently don't have legal authority to buy corporate bonds, but we would be surprised if that didn't come through, and that really would backstop risk, and would be a massive positive for anyone holding assets.
Excited about valuation opportunities
We're actually scared. But we're also really excited, because we know that the policymakers get it. They're all in — they'll do more. They will underwrite individual risk and underwrite corporate risk. There'll be some socialisation of risk. There'll be some nationalisations. But what we do think is large-cap, reason to exist, sensible governments and indeed corporates, whether investment grade or high yield, will get through this. They will survive, and I'm afraid other businesses won't survive.
So, we have mixed emotions. We're excited because we can see some fantastic valuation opportunities. We are cautious on some of the redemptions that we're seeing across the market. And if anything we're adding risk into ‘peak panic’ if you like. I think there's great opportunities here. We're very grateful to the support we're seeing from clients.
Going forwards, I think we'll get some piece out shortly on some of the amazing valuations we're seeing. Markets are more than pricing in a recession here and we can take good risk-adjusted returns at these levels. We’ll also have a piece out shortly regarding yield curve control, financial repression and so on, because there's a lot of issues to debate here and what we will do is keep our clients informed going forward.
Finally, we thank you very much. I know it's a tough time for all of us as a team; we're working well and we're completely focused on client outcomes. Thank you.
These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.
Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.
The information in this article does not qualify as an investment recommendation.
An issuer of a bond (or money market instrument) may become unable or unwilling to pay interest or repay capital to the Fund. If this happens or the market perceives this may happen, the value of the bond will fall.
When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise. This risk is generally greater the longer the maturity of a bond investment.
The Fund invests in high yield (non-investment grade) bonds and while these generally offer higher rates of interest than investment grade bonds, they are more speculative and more sensitive to adverse changes in market conditions.
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