(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.
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