(Bloomberg) — Corporate bond prices have soared to heights not seen in almost three decades, driven by a wave of investments from pension funds and insurers vying for assets. Despite this upward trajectory, many investors remain unfazed about the potential risks.
A large number of money managers seem to believe that these high valuations are here to stay. The premium over safer government bonds, known as spreads, might linger at these low levels for some time. This is partly because government deficits are making sovereign bonds less appealing.
“You might argue that spreads are too tight and it’s time to explore other opportunities, but that’s just one side of the story,” explains Christian Hantel, a portfolio manager at Vontobel. “Historically, there have been phases where spreads stayed tight for extended periods, and we are currently in such a phase.”
While some investors view these sky-high valuations as a red flag, they continue to find corporate bonds appealing due to historically high yields, irrespective of how these yields stack up against government debt. Some experts even predict further tightening of these spreads.
Matt Brill, a senior portfolio manager at Invesco, indicated at a Bloomberg Intelligence credit outlook conference in December that spreads on US investment-grade corporate bonds might shrink further to 55 basis points. As of last Friday, these spreads were around 80 basis points or 0.80 percent. Meanwhile, Europe and Asia are approaching historically low levels as well.
Hantel points out a few factors contributing to tight spreads, including reduced duration and improving bond quality, the tendency for discounted bonds to appreciate as they near repayment, and a more diversified market.
Take BB-rated bonds, for instance; they are becoming increasingly similar to blue-chip debt, enjoying their highest-ever share of global junk indexes. On the other hand, the share of BBB-rated bonds in high-grade indices—once a source of concern due to their downgrade risk—has been on the decline for over two years.
Investors are also honing in on “carry,” which in bond market terms, refers to the income earned from coupon payments after accounting for leverage costs.
“You don’t need much of a spread to achieve near double-digit returns in high-yield bonds,” said Mohammed Kazmi, a portfolio manager at Union Bancaire Privee. “It’s primarily about carry. Even if spreads widen, the total yield provides a cushion.”
Speaking of spreads, since the financial crisis, the cost related to default protections has rarely been this affordable. Historically, fund managers have used such periods to stock up on insurance, but currently, there’s insufficient buying pressure to lift credit default swap premiums.
That said, the broad narrowing of spreads has diminished the differential between financially stable and weaker issuers. Bond investors now receive less compensation for taking on additional risk, while weaker firms don’t face much higher costs than their robust counterparts when raising capital.
Nevertheless, it would require a considerable change in momentum to disrupt existing risk premiums.
“Although fixed-income spreads are tight, we believe a mixture of declining fundamentals and weakening technical dynamics would be needed to spark a change in the credit cycle, which isn’t our outlook for the upcoming year,” commented Gurpreet Garewal, macro strategist at Goldman Sachs Asset Management.
In the first two weeks of January, leading companies raised $15.1 billion in the US investment-grade primary debt market, signaling what might become one of the busiest starts to a year for bond sales. An additional $1 billion was raised by January 3rd.
Notable companies like Apollo Global Management scored a legal victory that potentially affects future “uptiering” deals. Financial maneuvers, such as these, are being closely watched following a pivotal court decision regarding Serta Simmons Bedding, which favored select investors in a debt rearrangement.
Meanwhile, The Container Store Group Inc. declared bankruptcy due to financial strain and mounting debt, and Big Lots Inc. secured court approval for a rescue deal to avert shutting down certain stores, despite objections from some vendors.
IHeartMedia completed a debt exchange, effectively extending debt maturities, although S&P likened it to a default. Carvana Co., the online car retailer, came under scrutiny from Hindenburg Research over alleged risks within its subprime loan portfolio.
In other corporate moves, MultiPlan Corp. struck a deal with creditors to extend debt maturities, Glosslab LLC, a nail salon chain in New York, filed for bankruptcy, and aerospace supplier Incora secured court backing to exit bankruptcy.
In public finance, municipal bonds issued by colleges and charter schools reached new levels of distress in 2024, with defaulted state and local government debt climbing to a three-year peak.
In senior appointments, Goldman Sachs named Alex Golten as its new chief risk officer, while Michael Occi has been appointed president of Morgan Stanley Direct Lending Fund, effective at the start of 2025. Additionally, Kommuninvest has selected Tobias Landstrom to head its debt management division.
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