Some corporates on the last rung of the credit rating ladder before entering junk status in the bond world, triple B, may lose their investment grade status as central banks continue their quantitative tightening programmes. This could lead to credit downgrades.
It could also be pretty devastating for some institution investors who want the extra yield triple B bonds provides but the safety of their investment grade status. These investors may not be mandated to hold high yield or junk bonds either.
Research from Legal & General Investment Management has shown that since 1995, triple B has grown from being around 20 percent of investment grade bond issuance to more than 50 percent today.
The warning over ‘large swathes’ of triple B corporates losing their investment grade status comes from Craig Veysey, lead fund manager of the Man GLG Strategic Bond fund.
Mr Veysey has also noted the ‘explosion’ of Triple B issuance as companies took advantage of ultra low interest rates to shore up their balance sheets to engage in shareholder friendly actions. These include financing share buy-backs and in some cases funding dividend payments.
At an LGIM event yesterday, CIO Anton Eser and deputy CIO Sonja Laud showed the room the implications of quantitative tightening. In 2018, when QT was in full swing, not one asset class produced returns that beat US inflation, which only stood at 1.9%.
The pair also showed that last year the real economy performed well but it was the markets lagging. This is a reversal of what had been happening since central banks opened the floodgates on monetary policy after the 2008 financial crisis when there was a large disconnect between asset prices and the real economy.
Mr Veysey also said in a statement that now central banks are no longer suppressing volatility, cyclical triple B issuers may be in trouble. While it may be true that volatility has returned to the markets, it is by no means high, it’s just not being suppressed by monetary policy.
The normalisation process was always going to be painful, central banks have $18 trillion of debt on their balance sheets. Now the process has started, markets will be more volatile without the central banks artificially inflating asset prices. It should be a good time for active managers who have struggled to beat the market when it has an irrational participant, a central bank.
In terms of credit, Mr Versey likes “fallen angels” like Tesco. “‘We have recently been buying bonds in Tesco, which has overseen a huge turnaround in the business,” he says. “Tesco is now only one rating agency upgrade away from moving from sub-investment grade to investment grade and we think that’s likely to happen in the next few months,” he said.
LGIM sees credit opportunities in emerging markets, as does Fundeye profiling an emerging market bond fund here.
