Unlock Editor’s Digest for free
FT editor Roula Khalaf has chosen her favorite stories in this weekly newsletter.
The market mantra now is “shut up and take the money,” and fear of missing out has permeated nearly every major asset class. Nowhere is this more evident than in corporate bonds.
The market has struggled to find its way into the mainstream spotlight this year, disappearing from view by the seemingly unstoppable behemoths of stocks. But just as stock prices have soared over the past six months, corporate credit has also been subject to strong investor demand.
The whole way fund managers talk about credit has changed. For years, they have touted the spread, the difference in returns that means investors are usually rewarded more for buying corporate bonds than for buying safer and more boring government bonds. This was the basis of credit investing.
Now, strong buying interest has narrowed spreads to their narrowest levels in decades. Investors receive little return from taking on this extra risk. In fact, in some special cases, corporate bonds pay more than government debt. The spread is pre-coronavirus, and all-in yield is the name of the game.
“There’s been massive inflows and it’s all about yield,” Loomis Sayles credit strategist Heather Lidil said at an event in London earlier this month. “When we say, ‘Spreads are tight,’ they say, ‘I don’t care, I want yield.'”
This doesn’t seem very healthy, but it’s easy to see how this happened. First, there is a shortage of corporate bonds, especially given that companies are returning relatively large sums of money to investors in the form of bond repayments.
Importantly, while benchmark interest rates have fallen since the pandemic-era inflation spike, they remain fairly generous by the standards of the past 15 years or so. This would set a higher floor for corporate borrowing costs, provide investors with more cushion if things go wrong, and strengthen the credit crunch. Companies will be reluctant to cap in debt investors if they know it will be a relatively expensive exercise. For investors, the spread may be very tight, but it’s better than nothing. “You’re getting something special,” said Tatiana Grail Castro, co-head of public markets at credit investment firm Muzinich. “It’s not a lot, but it increases over time.”
Some content could not be loaded. Please check your internet connection or browser settings.
Riskier borrowers often go through the private bond market rather than the public bond market. That is, companies that still have access to large amounts of debt investor capital tend to be safer and therefore deserve higher ratings and lower borrowing costs. Goldman Sachs notes that even the riskier so-called high-yield market is “less junk than ever.” Although risky corporate bonds come with unique risks, “from a risk perspective, high-yield indexes are now likely to be the safest they have ever been,” the bank wrote earlier this month.
Some even argue that corporate bonds often command higher price tags than benchmark government bonds, given companies’ greater ability to reduce costs and often lower overall relative debt levels. This is a bit of a funky claim considering that corporations can’t print their own money or manipulate inflation to eliminate debt burdens like governments can, but this is how the market is blowing up these days, especially given the political turmoil in France.
Some investors say enough is enough. They don’t feel they’re getting a fair reward for buying up the tiny yields on corporate bonds, so they turn to stocks instead, or if they want safety, they just buy government bonds that have marginally more generous yields.
However, overall inflows into this asset class have been impressive throughout the year. In fact, Loomis Sayles’ Lidil said, markets tend to become sharply volatile on days when money inflows are slightly slower than normal. It added that a full spill would likely cause “massive panic”.
Amid the buying frenzy in corporate bond funds, one consolation is that the primary market — where banks issue new bonds to the world — remains disciplined, bankers and investors say. Fund managers are unwilling to buy at old prices and tend to back out when bankers try their luck at stingy returns.
Even so, one-way traffic is unsettling. This reflects how the overall momentum is proving to be an irresistible force at the moment, from stocks to gold to silver to cryptocurrencies. It’s not just stocks that are plummeting, so is almost every other stock.
Recommended
“There’s definitely a huge fear of missing out,” Grail Castro said. “Everyone was afraid that there would be a recession in 2023, 2024, so many people still feel like they don’t have enough risk in their portfolios.”
This kind of hubris and enthusiasm is fine until it isn’t. Financial heavyweights including Citi’s Jane Fraser, JPMorgan’s Jamie Dimon and Apollo’s Mark Rowan have warned of global market excesses over the past week. Only the willfully ignorant can fail to realize that risk-taking is occurring at an astonishingly aggressive pace in almost every asset class.
Perhaps the only thing that would change the flow of corporate credit would be to change the flow of the financial system as a whole. If the mood deteriorates, risky asset classes will be inevitable.
katie.martin@ft.com
