(Bloomberg) — Corporate bond valuations are in nosebleed territory, issuing their biggest warning in nearly 30 years as an influx of money from pension fund managers and insurers fuels competition for assets. So far, investors are optimistic about the risks.
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Many money managers don’t see valuations coming back to Earth anytime soon. Spreads, the premium to buy corporate debt rather than safer government bonds, could remain low for an extended period, partly because fiscal deficits have made some sovereign debt less attractive.
“You can easily make a decision that spreads are too tight and you should go elsewhere, but that’s just part of the story,” said Christian Hantel, portfolio manager at Vontobel. “When you look at history, there have been several periods where spreads have remained tight for some time. We are in such a system at the moment.”
For some money managers, high valuations are a cause for concern, and there are risks now, including inflation affecting corporate profits. But investors who buy securities are attracted by yields that appear high by the standards of the past two decades, and are less focused on how they compare to government debt. Some even see room for more pressure.
Spreads on high-quality US corporate bonds could narrow to 55 basis points, Matt Brill, Invesco’s senior portfolio manager, said at a Bloomberg Intelligence credit outlook conference last December. It was quoted at 80 basis points on Friday, or 0.80 percentage point. Europe and Asia are also near their lowest levels in decades.
Hantell cited factors including lower index duration and improved quality, the tendency for discounted bond prices to rise as they approach maturity, and a more diversified market as trends that will keep spreads narrow.
Take BB-rated bonds, which have more in common with blue-chip corporate debt than with highly speculative bonds. They are close to their highest ever share in global waste indexes. In addition, the percentage of BBB bonds in high-quality bonds — a major source of concern in previous years because of the high risk of being downgraded to junk — has been declining for more than two years.
Investors are also focusing on carry, which is industry parlance for the money bondholders make from coupon payments after any leverage costs.
“You don’t necessarily need a lot of spread to get close to double-digit returns” in high yield, said Mohammad Kazemi, portfolio manager and chief fixed income strategist at Union Banker Privé. “It’s mostly a carry story. Even if you see wider spreads, you have a buffer of overall return.
Tighter spreads also mean that since the financial crisis, the cost of protecting against default – or at least the price of hedging against market volatility – has rarely been as low as current levels. Fund managers have taken advantage of similar periods of cheapness in the past to build insurance, but until now there has not been enough buying pressure to increase CDS premiums.
Certainly, higher interest rates on everything have narrowed the gap between stronger and weaker issuers in the credit market. Bond buyers get paid less for taking on more risk, while companies with fragile balance sheets don’t pay much higher than their more solid counterparts when raising money.
However, it will take a significant shift in momentum to raise the risk premium.
“While fixed income spreads are tight, we believe a combination of deteriorating fundamentals and weak technical dynamics is needed to trigger a turnaround in the credit cycle, which is not our base case for next year,” said Gurpreet Garewal, strategist and macroeconomist. Co-Head of Public Markets Investment Insights at Goldman Sachs Asset Management.
Two weeks in review
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A slew of major companies raised a total of $15.1 billion in the US investment-grade primary debt market on January 2, as underwriters prepare for what is expected to be one of the busiest Januarys for bond sales. Another $1 billion in sales occurred on Friday, January 3.
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Apollo Global Management Inc. won. and other financial heavyweights with a major lawsuit, effectively undoing a financing deal from which they were excluded in favor of Serta Simmons Bedding, a company whose debt they were holding. Serta has allowed a handful of investors to offer $200 million to the company in exchange for progress down the line that will be repaid if the bed maker fails. The decision may raise questions about whether other “upgrading” transactions will be allowed to occur.
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Container Store Group Inc. introduced filed for bankruptcy to address the mounting losses and heavy debt load affecting the chain.
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Bankrupt retailer Big Lots Inc. The court approved a rescue deal to save some of its stores from closure despite challenges from sellers who claimed that the deal unfairly burdened them with huge losses.
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IHeartMedia Inc. said: It has completed an offer to exchange some of its debt, extend maturities and reduce principal, in a move Standard & Poor’s described as “the equivalent of a default.”
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Carvana, an online seller of used cars that borrowed in the junk bond and ABS markets, has been accused by prominent short seller Hindenburg Research of wrongdoing in a report alleging the company’s mortgage loan portfolio was too risky and its growth was unsustainable.
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Healthcare analytics company MultiPlan Corp. has reached an agreement with the majority of its creditors to extend the maturities of its existing debt.
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Glosslab LLC, a New York City-based nail salon chain that experimented with a membership-based business model and attracted celebrity investors, has filed for bankruptcy.
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Space supplier Encora has received court permission to emerge from bankruptcy after announcing that its senior creditors have agreed to support a restructuring after years of acrimony over a notorious financing maneuver that pitted lenders against each other.
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Municipal bonds sold by colleges and charter schools become defaulted at record levels in 2024, as the amount of defaulted debt by states and local governments reaches a three-year high.
On the move
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Goldman Sachs Group has appointed Alex Golten to the position of Chief Risk Officer. Earlier in his career, Gulten was the company’s chief credit risk officer.
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Morgan Stanley Direct Lending Fund has appointed Michael Ouchi as President effective January 1, 2025.
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Kommuninvest has appointed Tobias Lundström as its new Head of Debt Management.
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