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Past performance is no guarantee of future results.
History doesn’t always repeat itself. A profound shift in the US corporate bond market will likely make the next crisis – whenever it comes – look quite different to previous ones. Compared to previous cycles, the proportion of bonds with the lowest possible investment grade rating (IG) – BBB – is exceptionally high, having increased sharply over the past decade. BBB-rated debt now accounts for around half of the whole market in both Europe and the US (see chart).
Share of BBB-rated debt in US IG universe, %
Source: ICE BofAML US Corporates Index (IG), Datastream. Data covering 19.09.2008-21.09.2018
One reason for the increase is that more firms have been turning to the credit market for funding as banks have scaled back lending in response to tougher regulations. At the same time, companies have been borrowing heavily to fund acquisitions – indeed firms operating in the telecom and consumer sectors, which have been particularly active in M&A, make up a substantial proportion of BBB-rated bonds – each sector accounts for around 8 per cent of the universe. Meanwhile, there has also been an increase in debt-funded buybacks and dividend payouts.
Consequently, today’s investment-grade bond market is, in aggregate, significantly more risky than in the past.
This is a problem because in periods when economies slow, or default rates rise, a significant proportion of BBB-rated borrowers tend to be downgraded as their finances deteriorate. This pushes them out of the investment-grade universe and down in to the high yield market. Sectors that are more defensive and have struggled to keep up with the broader pace of earnings growth would tend to be hit hardest. Portfolios which mostly or exclusively focus on investment-grade debt would therefore be forced to sell.
ICE BofAML US credit market indices, full market value, in USD million
Source: Datasteam. Data covering 19.09.2008 – 21.09.2018.
The only way for this mass of fallen angels to be absorbed by the market at a time when liquidity conditions are likely to be strained is through price. This will also affect new issuance, as costs for borrowers rise.
Consequently, we think both investment grade and high-yield bonds are riskier than their yields currently suggest. While we do not anticipate an imminent end to the credit cycle, as it grows ever longer in the tooth ever more stresses will appear. We think the predominance of BBB-rated paper make investment-grade bonds among the least attractive parts of the debt market.
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This document is used for informational purposes only and does not constitute, on Pictet Asset Management part, an offer to buy or sell solicitation or investment advice. It has been established on the basis of data, projections, forecasts, anticipations and hypothesis which are subjective. Its analysis and conclusions are the expression of an opinion, based on available data at a specific date. The effective evolution of the economic variables and values of the financial markets could be significantly different from the indications communicated in this document.
Information, opinions and estimates contained in this document reflect a judgment at the original date of publication and are subject to change without notice. Pictet Asset Management has not taken any steps to ensure that the securities referred to in this document are suitable for any particular investor and this document is not to be relied upon in substitution for the exercise of independent judgment. Tax treatment depends on the individual circumstances of each investor and may be subject to change in the future. Before making any investment decision, investors are recommended to ascertain if this investment is suitable for them in light of their financial knowledge and experience, investment goals and financial situation, or to obtain specific advice from an industry professional.
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Past performance is not a guarantee or a reliable indicator of future performance. Performance data does not include the commissions and fees charged at the time of subscribing for or redeeming shares. This marketing material is not intended to be a substitute for the fund’s full documentation or for any information which investors should obtain from their financial intermediaries acting in relation to their investment in the fund or funds mentioned in this document.
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