Investment Grade
Investment grade credit – the sweet spot in fixed income?
5 min read 15 Feb 23
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At this stage of the economic cycle, we think investment grade corporate bonds look especially well placed, offering an attractive real yield combined with resilience and diversification qualities to help withstand a more challenging market backdrop.
While the global economic outlook remains subdued, we believe that corporate bond markets are pricing in an awful lot of the bad news. Investment grade credit spreads are reflecting an implied default rate well in excess, not only of average default rates, but also of the worst default rate experience. We think this reflects an excessively gloomy outlook for default rates, and we believe investors are being well paid to take credit risk.
One of the most attractive features of corporate bonds is that they provide exposure to both the risk-free rate (government bond yields) and a risk premium (the spread between the yield of government bonds and corporate bonds). These two elements typically – though not always – move in opposite directions to each other, providing almost an in-built hedge against adverse market conditions.
By 2020, the risk-free rate had largely disappeared and, as a consequence, we were very cautiously positioned over that period. The good news is that the risk free rate is back today and this makes us much more positive on the asset class. In the event that the economic slowdown turns out to be more severe than anticipated, we would expect the risk-free rate to fall, and this should at least partly offset any weakness in credit markets.
Natural diversification elements of corporate bonds – rate and spread components provide separate drivers
Past performance is not a guide to future performance
