BBB debt — it’s complicated

07/03/2019

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​Nicholas Ware, Portfolio Manager within the Strategic Fixed Income team, discusses the unusually rapid growth of the BBB market for bonds and the implications for the high yield market given where we are in the economic cycle.

There has been an explosive growth in BBB rated debt — bond issues just one notch above high yield — in this economic cycle, driven by the cheap cost of funding and aided by quantitative easing measures. This has been highlighted by numerous people in the market, with warnings that it is unsustainable as the quantum of corporate debt is large; and in particular that of the lowest investment grade debt (rated BBB), which is now US$2.8 trillion in size in the US. Chart 1 shows how BBBs now represent just over half of all outstanding US$ denominated investment grade corporate bonds, and chart 2 shows the growth in these bonds, which has overtaken the combined volume of high yield and leveraged loans in the last few years.

Chart 1: BBBs are the biggest portion of the investment grade index

Chart 2: BBB volumes now outpace high yield and leveraged loans combined

Source: Barclays Research, Factset, Bloomberg, CapIQ, Janus Henderson Investors, as at 31 December 2018

Source: Barclays Live, Bloomberg, S&P LCD, Janus Henderson Investors, as at 31 December 2018

The debt diet

So, why did companies increase leverage and why were the rating agencies so lenient?

Companies have used debt markets for merger and acquisition (M&A) activities, share buy-backs and also to fund dividends, making a conscious decision to lever up given the cheap funding costs.

Additionally, rating agencies have been particularly generous, as the leverage on a number of companies does not resemble what we consider to be investment grade (net debt/EBITDA of less than 3x) and actually look more like high yield. The rating agencies have seemingly drawn comfort from verbal commitments; that companies want to remain investment grade and that they are committed to bringing leverage down over a number of years to levels more suitable for the rating.

Another reason why leverage is rising is that some companies are in structural/secular decline and have seen leverage rise as their financial situation worsened. These companies are, in effect, not in control of their leverage trajectory. This, to our mind, is a much more dangerous issue.

Fallen angels’ potential to disrupt

We have been watching this trend for some time now and for a number of years it did not matter much. The economic cycle was in its growth phase and people believed that companies could grow into their capital structure; ie, grow profitability to reduce leverage ratios.

However, it matters more now as we near the end of the cycle. Debt burdens need to be serviced and leverage brought down, which may prove to be difficult as the economy weakens. It matters to investors too if companies move from investment grade to high yield (rated BBB- or better to BB+ or worse) — what is known as becoming a ‘fallen angel’.

For example, the high yield market in the US is c.$1.2trn in size. If a large investment grade corporate were to be downgraded, its size could overwhelm that market, leading to disorderly moves in credit spreads (the difference in the yield of corporate bonds over equivalent government bonds, in effect, the extra premium needed to hold riskier bonds). This is because a number of high yield funds can hold no more than 2% per issuer in the index in their portfolios, and are thus constrained by how much they could hold.

Further, where the market fears a downgrade for an investment grade issuer, its debt will start trading wider as people anticipate the move into high yield. This impacts the company’s cost of funding and the ability to fund itself, which matters to both credit and equity investors. Forced selling by funds that focus on investment grade will also exacerbate the problem.

We are aware of this risk, given that holding a fallen angel (transitioning to high yield) can lead to price falls. From 2003-16, the average price performance of fallen angels was -10% in the three months leading up to the event. Chart 3 depicts this average price performance for each year over that period.

Chart 3: performance negative ahead of downgrade

Source:Credit Suisse, Janus Henderson Investors, 31 December 2003 to 31 December 2016. Past performance is not a guide to future performance.

Likely candidates to be ‘disruptive’ fallen angels

In order to determine the possibility of disruptive fallen angels moving into the high yield market, table 1 shows the key fundamental metrics of some of the larger investment grade issuers rated BBB, which are greater than 2% of the high yield market.

Table 1: key fundamental metrics for the likely candidates

Source:Janus Henderson Investors, as at 19 February 2019
Note:All figures are in US$ billions

There are 13 companies that can be classified as potential disruptive fallen angels. However, many have levers, which can be pulled to manage leverage. These include:

  • Cutting dividends
    A number of companies consider this to be sacrosanct and take great pride in increasing dividends. However, Anheuser-Busch InBev, in conjunction with its Q3 2018 earnings results, announced a 50% reduction in its dividend. We think more will follow this route.
  • Asset sales
    Both AT&T and General Electric (GE) have recently announced plans to sell assets to help meet their leverage targets. Again, this is a sensible course of action but if the economy turns for the worst this possibility diminishes, as private equity and corporate willingness to pay the price that the seller is looking for reduces.
  • Reduce capital/operational spending
    Cutting capital and operational expenditure is another way to generate cash flow to delever (reduce debt) but this is possibly at the expense of future growth.
  • Refinancing near-term maturities
    Recently AT&T announced a new US$5 billion deal to refinance some of its 2021 maturities. This follows similar actions by firms such as Anheuser-Busch InBev and Verizon in recent weeks, all of which have used tenders or exchanges to term out (extend) maturities over the next few years (in some cases, through 2026).

Getting religion

We have summarised what we view as the prospects for these larger issuers in chart 4. In our minds they can be split into two distinct sects: those who can ‘self help’ and pull themselves out of the quagmire; and those who are helpless to their prospects. The latter group have cyclical and structural problems and are thus in what we call ‘structural decline’* — of which Ford is arguably the worst.

The first group must embrace deleveraging religiously to avoid a downgrade, while as mentioned earlier the trajectory of leverage for the second group is most likely out of their hands, making the downgrade almost inevitable.

Chart 4: ability to maintain investment grade rating?

Source:Janus Henderson Investors, as at 01 March 2019

Based on our analysis, there is a strong possibility that Ford could be downgraded to high yield. The market has also started factoring in the possibility, as the price on the Ford 4.346% 2026 bonds has fallen by around 8 points (one point = 1% of 100 par value) since the middle of July 2018. The company has been a high yield business in the past (2005-12), so it does have a track record of operating at that rating level.

Ford’s main credit challenge is improving the performance of its businesses outside of North America and this has weakened its credit metrics. We believe the issue is for the finance company at Ford, who may have to shift to more secured financing (such as asset-backed securities) and away from unsecured bond financing, to keep access and favourable pricing for its customers.

Playing the cycles

Looking at chart 5, it is clear is that BBBs are higher beta (more volatile) than other credit rating categories, but equally, once the market recovers, they tend to outperform.

However, in the current climate we are wary of BBBs and believe that they represent a greater risk than their yields might suggest and much prefer to be invested either side in single A and double B rated issuers that historically have presented a steadier profile, relatively speaking. It is of course all down to stock selection; separating the self help entities from the rest. In addition, exploring BBB strategies makes sense when the cycle turns but should be done selectively at the end of the cycle.

Chart 5: BBBs are higher beta

Source:ICE BoAML, Bloomberg, Janus Henderson Investors, as at 31 January 2019
Note:Par weighted price for BBB, AA and A US Non Financial Corporate indices. Past performance is not a guide to future performance.

Final thoughts

Our more optimistic view is that many of the larger issuers have levers, which they can pull to protect their credit ratings. However, there is scope for accidents. If the economy slows, it may delay the prospects for de-leveraging, endangering the companies’ ratings. A general rule of thumb, which we follow and which helps us identify problems further down the line, is to follow the debt growth.

Very simply, the explosive growth of BBBs is one of the excesses of the cycle and will be one of the problem areas when the economy turns down. Thus, this is an area of the markets where we will be cautious and selective.



*Structural decline: when changes in society such as changing demographics, consumer behaviour, low-growth economics and technology-driven disruption act against a business model




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.

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Janus Henderson Fixed Interest Monthly Income Fund

This document is intended solely for the use of professionals and is not for general public distribution.

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. Tax assumptions and reliefs depend upon an investor’s particular circumstances and may change if those circumstances or the law change.

If you invest through a third party provider you are advised to consult them directly as charges, performance and terms and conditions may differ materially.

Nothing in this document is intended to or should be construed as advice. This document is not a recommendation to sell or purchase any investment. It does not form part of any contract for the sale or purchase of any investment.

Any investment application will be made solely on the basis of the information contained in the Prospectus (including all relevant covering documents), which will contain investment restrictions. This document is intended as a summary only and potential investors must read the prospectus, and where relevant, the key investor information document before investing. Copies of the Fund’s prospectus and key investor information document are available in English, French, German, and Italian. Articles of incorporation, annual and semi-annual reports are available in English. All of these documents can be obtained free of cost from Janus Henderson Investors registered office: 201 Bishopsgate, London EC2M 3AE.

Issued in the UK by Janus Henderson Investors. Janus Henderson Investors is the name under which investment products and services are provided by Janus Capital International Limited (reg no. 3594615), Henderson Global Investors Limited (reg. no. 906355), Henderson Investment Funds Limited (reg. no. 2678531), AlphaGen Capital Limited (reg. no. 962757), Henderson Equity Partners Limited (reg. no.2606646), (each registered in England and Wales at 201 Bishopsgate, London EC2M 3AE and regulated by the Financial Conduct Authority) and Henderson Management S.A. (reg no. B22848 at 2 Rue de Bitbourg, L-1273, Luxembourg and regulated by the Commission de Surveillance du Secteur Financier). We may record telephone calls for our mutual protection, to improve customer service and for regulatory record keeping purposes.

Copies of the Fund’s prospectus are available in English, French, Spanish German and Dutch. Key investor information documents are available in English, Danish, German, Finnish, French, Italian, Norwegian, Spanish, Swedish and Dutch. Articles of incorporation, annual and semi-annual reports are available in English. All of these documents can be obtained free of cost from the local offices of Janus Henderson Investors: 201 Bishopsgate, London, EC2M 3AE for UK, Swedish and Scandinavian investors; Via Dante 14, 20121 Milan, Italy, for Italian investors and Roemer Visscherstraat 43-45, 1054 EW Amsterdam, the Netherlands. for Dutch investors; and the Fund’s: Austrian Paying Agent Raiffeisen Bank International AG, Am Stadtpark 9, A-1030 Vienna; French Paying Agent BNP Paribas Securities Services, 3, rue d’Antin, F-75002 Paris; German Information Agent Marcard, Stein & Co, Ballindamm 36, 20095 Hamburg; Belgian Financial Service Provider CACEIS Belgium S.A., Avenue du Port 86 C b320, B-1000 Brussels; Spanish Representative Allfunds Bank S.A. Estafeta, 6 Complejo Plaza de la Fuente, La Moraleja, Alcobendas 28109 Madrid; Janus Henderson Investors (Singapore) Limited, 138 Market Street #34-03/04 CapitaGreen, Singapore 048946; or Swiss Representative BNP Paribas Securities Services, Paris, succursale de Zurich, Selnaustrasse 16, 8002 Zurich who are also the Swiss Paying Agent.

Specific risks

  • Some or all of the Annual Management Charge and other costs of the Fund may be taken from capital, which may erode capital or reduce potential for capital growth.
  • This fund is designed to be used only as one component in several in a diversified investment portfolio. Investors should consider carefully the proportion of their portfolio invested into this fund.
  • The Fund could lose money if a counterparty with which it trades becomes unwilling or unable to meet its obligations to the Fund.
  • When the Fund, or a currency hedged share class of the Fund (with ‘Hedged’ in its name), seeks to mitigate (hedge) exchange rate movements of a currency relative to the Fund’s base currency, the hedging strategy itself may create a positive or negative impact to the value of the Fund due to differences in short-term interest rates between the currencies.
  • 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.
  • The Fund may use derivatives towards the aim of achieving its investment objective. This can result in 'leverage', which can magnify an investment outcome and gains or losses to the Fund may be greater than the cost of the derivative. Derivatives also introduce other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
  • Changes in currency exchange rates may cause the value of your investment and any income from it to rise or fall.
  • If the Fund or a specific share class of the Fund seeks to reduce risks (such as exchange rate movements), the measures designed to do so may be ineffective, unavailable or detrimental.
  • 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.
  • 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.
  • Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.

Risk rating

Janus Henderson Preference & Bond Fund

This document is intended solely for the use of professionals and is not for general public distribution.

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. Tax assumptions and reliefs depend upon an investor’s particular circumstances and may change if those circumstances or the law change.

If you invest through a third party provider you are advised to consult them directly as charges, performance and terms and conditions may differ materially.

Nothing in this document is intended to or should be construed as advice. This document is not a recommendation to sell or purchase any investment. It does not form part of any contract for the sale or purchase of any investment.

Any investment application will be made solely on the basis of the information contained in the Prospectus (including all relevant covering documents), which will contain investment restrictions. This document is intended as a summary only and potential investors must read the prospectus, and where relevant, the key investor information document before investing. Copies of the Fund’s prospectus and key investor information document are available in English, French, German, and Italian. Articles of incorporation, annual and semi-annual reports are available in English. All of these documents can be obtained free of cost from Janus Henderson Investors registered office: 201 Bishopsgate, London EC2M 3AE.

Issued in the UK by Janus Henderson Investors. Janus Henderson Investors is the name under which investment products and services are provided by Janus Capital International Limited (reg no. 3594615), Henderson Global Investors Limited (reg. no. 906355), Henderson Investment Funds Limited (reg. no. 2678531), AlphaGen Capital Limited (reg. no. 962757), Henderson Equity Partners Limited (reg. no.2606646), (each registered in England and Wales at 201 Bishopsgate, London EC2M 3AE and regulated by the Financial Conduct Authority) and Henderson Management S.A. (reg no. B22848 at 2 Rue de Bitbourg, L-1273, Luxembourg and regulated by the Commission de Surveillance du Secteur Financier). We may record telephone calls for our mutual protection, to improve customer service and for regulatory record keeping purposes.

Copies of the Fund’s prospectus are available in English, French, Spanish German and Dutch. Key investor information documents are available in English, Danish, German, Finnish, French, Italian, Norwegian, Spanish, Swedish and Dutch. Articles of incorporation, annual and semi-annual reports are available in English. All of these documents can be obtained free of cost from the local offices of Janus Henderson Investors: 201 Bishopsgate, London, EC2M 3AE for UK, Swedish and Scandinavian investors; Via Dante 14, 20121 Milan, Italy, for Italian investors and Roemer Visscherstraat 43-45, 1054 EW Amsterdam, the Netherlands. for Dutch investors; and the Fund’s: Austrian Paying Agent Raiffeisen Bank International AG, Am Stadtpark 9, A-1030 Vienna; French Paying Agent BNP Paribas Securities Services, 3, rue d’Antin, F-75002 Paris; German Information Agent Marcard, Stein & Co, Ballindamm 36, 20095 Hamburg; Belgian Financial Service Provider CACEIS Belgium S.A., Avenue du Port 86 C b320, B-1000 Brussels; Spanish Representative Allfunds Bank S.A. Estafeta, 6 Complejo Plaza de la Fuente, La Moraleja, Alcobendas 28109 Madrid; Janus Henderson Investors (Singapore) Limited, 138 Market Street #34-03/04 CapitaGreen, Singapore 048946; or Swiss Representative BNP Paribas Securities Services, Paris, succursale de Zurich, Selnaustrasse 16, 8002 Zurich who are also the Swiss Paying Agent.

Specific risks

  • Some or all of the Annual Management Charge and other costs of the Fund may be taken from capital, which may erode capital or reduce potential for capital growth.
  • This fund is designed to be used only as one component in several in a diversified investment portfolio. Investors should consider carefully the proportion of their portfolio invested into this fund.
  • The Fund could lose money if a counterparty with which it trades becomes unwilling or unable to meet its obligations to the Fund.
  • When the Fund, or a currency hedged share class of the Fund (with ‘Hedged’ in its name), seeks to mitigate (hedge) exchange rate movements of a currency relative to the Fund’s base currency, the hedging strategy itself may create a positive or negative impact to the value of the Fund due to differences in short-term interest rates between the currencies.
  • 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.
  • The Fund may use derivatives towards the aim of achieving its investment objective. This can result in 'leverage', which can magnify an investment outcome and gains or losses to the Fund may be greater than the cost of the derivative. Derivatives also introduce other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
  • Changes in currency exchange rates may cause the value of your investment and any income from it to rise or fall.
  • If the Fund or a specific share class of the Fund seeks to reduce risks (such as exchange rate movements), the measures designed to do so may be ineffective, unavailable or detrimental.
  • 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.
  • 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.
  • Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.

Risk rating

Janus Henderson Strategic Bond Fund

This document is intended solely for the use of professionals and is not for general public distribution.

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. Tax assumptions and reliefs depend upon an investor’s particular circumstances and may change if those circumstances or the law change.

If you invest through a third party provider you are advised to consult them directly as charges, performance and terms and conditions may differ materially.

Nothing in this document is intended to or should be construed as advice. This document is not a recommendation to sell or purchase any investment. It does not form part of any contract for the sale or purchase of any investment.

Any investment application will be made solely on the basis of the information contained in the Prospectus (including all relevant covering documents), which will contain investment restrictions. This document is intended as a summary only and potential investors must read the prospectus, and where relevant, the key investor information document before investing. Copies of the Fund’s prospectus and key investor information document are available in English, French, German, and Italian. Articles of incorporation, annual and semi-annual reports are available in English. All of these documents can be obtained free of cost from Janus Henderson Investors registered office: 201 Bishopsgate, London EC2M 3AE.

Issued in the UK by Janus Henderson Investors. Janus Henderson Investors is the name under which investment products and services are provided by Janus Capital International Limited (reg no. 3594615), Henderson Global Investors Limited (reg. no. 906355), Henderson Investment Funds Limited (reg. no. 2678531), AlphaGen Capital Limited (reg. no. 962757), Henderson Equity Partners Limited (reg. no.2606646), (each registered in England and Wales at 201 Bishopsgate, London EC2M 3AE and regulated by the Financial Conduct Authority) and Henderson Management S.A. (reg no. B22848 at 2 Rue de Bitbourg, L-1273, Luxembourg and regulated by the Commission de Surveillance du Secteur Financier). We may record telephone calls for our mutual protection, to improve customer service and for regulatory record keeping purposes.

Copies of the Fund’s prospectus are available in English, French, Spanish German and Dutch. Key investor information documents are available in English, Danish, German, Finnish, French, Italian, Norwegian, Spanish, Swedish and Dutch. Articles of incorporation, annual and semi-annual reports are available in English. All of these documents can be obtained free of cost from the local offices of Janus Henderson Investors: 201 Bishopsgate, London, EC2M 3AE for UK, Swedish and Scandinavian investors; Via Dante 14, 20121 Milan, Italy, for Italian investors and Roemer Visscherstraat 43-45, 1054 EW Amsterdam, the Netherlands. for Dutch investors; and the Fund’s: Austrian Paying Agent Raiffeisen Bank International AG, Am Stadtpark 9, A-1030 Vienna; French Paying Agent BNP Paribas Securities Services, 3, rue d’Antin, F-75002 Paris; German Information Agent Marcard, Stein & Co, Ballindamm 36, 20095 Hamburg; Belgian Financial Service Provider CACEIS Belgium S.A., Avenue du Port 86 C b320, B-1000 Brussels; Spanish Representative Allfunds Bank S.A. Estafeta, 6 Complejo Plaza de la Fuente, La Moraleja, Alcobendas 28109 Madrid; Janus Henderson Investors (Singapore) Limited, 138 Market Street #34-03/04 CapitaGreen, Singapore 048946; or Swiss Representative BNP Paribas Securities Services, Paris, succursale de Zurich, Selnaustrasse 16, 8002 Zurich who are also the Swiss Paying Agent.

Specific risks

  • Some or all of the Annual Management Charge and other costs of the Fund may be taken from capital, which may erode capital or reduce potential for capital growth.
  • This fund is designed to be used only as one component in several in a diversified investment portfolio. Investors should consider carefully the proportion of their portfolio invested into this fund.
  • The Fund could lose money if a counterparty with which it trades becomes unwilling or unable to meet its obligations to the Fund.
  • If a Fund has a high exposure to a particular country or geographical region it carries a higher level of risk than a Fund which is more broadly diversified.
  • When the Fund, or a currency hedged share class of the Fund (with ‘Hedged’ in its name), seeks to mitigate (hedge) exchange rate movements of a currency relative to the Fund’s base currency, the hedging strategy itself may create a positive or negative impact to the value of the Fund due to differences in short-term interest rates between the currencies.
  • 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.
  • The Fund may use derivatives towards the aim of achieving its investment objective. This can result in 'leverage', which can magnify an investment outcome and gains or losses to the Fund may be greater than the cost of the derivative. Derivatives also introduce other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
  • If the Fund or a specific share class of the Fund seeks to reduce risks (such as exchange rate movements), the measures designed to do so may be ineffective, unavailable or detrimental.
  • 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.
  • 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.
  • Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.

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