Giving undue credit?

14/06/2019

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Oliver Blackbourn & Jamie Sandells of the Janus Henderson UK-based Multi-Asset Team on the reported decrease in corporate credit quality and the impact on US IG corporate bond credit spreads.

 
Among the various warning messages circulating recently, the decrease in corporate credit quality has featured heavily. The shift has been sizeable but we wondered what impact it should have had on the average credit spread of the US investment grade corporate bond market. Have we been relying on a historic comparison that wasn’t valid anymore? Thankfully, it turns out that not much should have changed.
 
The split of credit ratings in the US dollar investment grade corporate bond market has shifted significantly as the amount of bonds in the BBB-rated (or Baa-rated, depending on the agency) has expanded. Back at the end of the millennium, BBB-rated debt equated to around 30% of the total market size. Over the last 19 years, this proportion has grown to 50% of the corporate bond market. Many point to this as a fundamental change in the nature of the corporate bond market. Therefore, we wondered if we were making a mistake when comparing the current average spread of the market to history.
 
Composition of the US investment grade corporate bond market by credit rating
 

 Source:  Janus Henderson Investors, Bloomberg, as at 10 June 2019

To examine the effect, we wanted to approximate the impact on the average credit spread of the US investment grade market that the changing credit rating mix should have caused. We took the weighting for each credit rating segment (AAA, AA, A & BBB) at the end of 1999 and rebuilt the overall index through time. We then compared this re-weighted index to the average credit spread of the US market over time. As you might expect, the credit spread was wider; however, the difference today would only be about 15 basis points, or around 10-15% wider.
 
Reweighting the index results in only fractional change
 
 
 Source:  Janus Henderson Investors, Bloomberg, as at 10 June 2019

In truth, we were surprised at just how small the overall difference was given the scale of the shift into BBB-rated debt – around a 20% shift in total. It is also worth noting that the impact has mainly come after the Great Financial Crisis. As the following chart shows, credit spreads are now over 10% wider (14 basis points in actual spread terms) than they would have been. While there was a spike following the tech bubble that reset fairly quickly, there has been a more persistent shift post-2009. While not covered in detail here, we can see a much more significant change in the euro investment grade corporate bond market. However, the euro market has been through greater change over the same period, with the weight in BBB-rated debt rising from below 10% to 50%, and the segment covering both AAA and AA-rated bond falling from 60% to 10%.
 
 
Relative impact of changing credit rating mix on US investment grade credit spreads
 


 Source:  Janus Henderson Investors, Bloomberg, as at 10 June 2019
 
From a multi-asset perspective, the impact on the credit spread of the overall US investment grade market seems fairly minor, in the context of swings in credit spreads over a market cycle. For those in need of income, this slight increase in spreads may be a (very) small relief given the higher average coupon at a time of low yields, although it is important to note that this higher rate of return does come with a higher attached risk. However, in the end we feel comfortable that historical spreads remain a reasonable comparator for the US market today.
 
US credit spreads currently reflect greater uncertainty - be that political, economic or higher leverage. They do not reflect a cheap market but we think that investment grade bonds sit well within our multi-asset portfolios, particularly given our preference for mid-risk assets in a post-stimulus environment.

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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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.

Past performance is not a guide to future performance. The performance data does not take into account the commissions and costs incurred on the issue and redemption of units. 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.

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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. Key Investor document is also available in Spanish. 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. RBC Investor Services Trust Hong Kong Limited, a subsidiary of the joint venture UK holding company RBC Investor Services Limited, 51/F Central Plaza, 18 Harbour Road, Wanchai, Hong Kong, Tel: +852 2978 5656 is the Fund’s Representative in Hong Kong.

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