The safest corporate bonds in the world are having their worst start to the year in just over two decades as investors brace for tighter monetary policies.
A global index of investment-grade company debt has posted total return losses of 2.2% since the start of the year, the most since data going back to 2000. The gauge is faring worse than all others in the category of credit securities outside of emerging markets.
With yields rising to levels last seen before the pandemic on Treasuries and German bunds, investment-grade bonds look vulnerable to rate hikes and could attract more defensive bets. Those borrowers typically issue notes with longer maturities, and their greater duration -- a measure of price sensitivity to rate moves -- spurs steeper drops as yields climb.
Investment-grade bonds are where the trouble starts “when you go from a bull market to something more bearish,” Viktor Hjort, global head of credit strategy at BNP Paribas SA, said in an interview. “As we reach some of the inflection points in the market cycle, the IG corporate bond market will be hit first.”
Other market dynamics are adding to the pressure. BNP Paribas’s Hjort anticipates a jump in bond issuance this year as companies need to invest in infrastructure and supply centers, among other projects. At the other end, demand from central banks may ease, especially as the European Central Bank prepares to wind down its pandemic bond-buying program in March. This supply-demand imbalance can boost risk premiums.
Investors are taking note. Pacific Investment Management Co. is reducing the share of corporate bonds in its credit portfolios, even though it’s overweight in the credit market, according to a recent cyclical outlook. Instead, it’s looking at credit-default swaps and structured credit, such as non-agency mortgage-backed securities, according to Eve Tournier, credit portfolio manager.
“As well as offering diversification, these can improve the convexity of our portfolios through their defensive qualities,” she said in an interview, referring to a measure of interest-rate risk.
Indeed, baskets of credit-default swaps -- contracts that provide insurance against corporate defaults -- have been much more resilient this year. Both in North America and Europe, total return losses for investment-grade CDS indexes this year are a fraction of bond returns.
“Yields are going to go a little bit higher before things start to stabilize,” said Winnie Cisar, global head of strategy at CreditSights. “For retail investors right now, it’s hard to see those total return losses and kind of stick with the trades.”
Institutional investors with a longer-duration yield mandate may be attracted to all-in yields on U.S. investment-grade credit of 3%, according to Cisar. The yield to worst on Bloomberg’s high-grade index jumped as high as 2.72% this week, from 2.33% at the start of the year.