Fire sale in EUR investment grade credits?
Since the beginning of the war against Ukraine, credit spreads have come under pressure. This is particularly evident in EUR investment grade spreads which have widened significantly in this environment.
Dr. Veronika Herzberger
Head of Fixed Income Portfolio Management
EUR investment grade issuers have come under more pressure than their US peers and spread widening has further progressed compared to EUR high yield. If we look at the ratio of investment grade spreads to high yield spreads, we are near all-time highs.
Ratio of investment grade spreads to high yield spreads
What are the drivers of the widening and why is EUR credit the most affected?
Fears of a recession, as currently already priced in, are driving spreads higher as investors become increasingly concerned about deteriorating balance sheets and an erosion of credit quality. Sector specifics aside, investment grade and high yield bonds are generally affected in a similar way, so we find no explanation here for the different extent of the widening.
In terms of supply and demand, there are major differences between EUR high-yield and EUR investment-grade bonds. EUR investment grade bond issuers are still very active in the primary markets (issuance so far this year is largely in line with the very high level of the previous year). In high-yield bonds, on the other hand, only about a third of the volume of the previous year was issued. The high volume of new issuance has to be digested by the markets at a time when we are seeing outflows from the asset class by retail investors and at the same time the ECB is dropping out as a buyer of investment grade paper.
New issue premiums are high
In the absence of excessive investor demand, new issues can only be sold at an attractive price. Premiums for new issues are therefore high, which in turn puts pressure on the secondary curve of the respective issuer and the credit market. However, building up a cash cushion improves the liquidity situation of investment grade names in general which is credit positive. Not every single name widening therefore is automatically a sign of deteriorating credit quality or fear of balance sheet erosion.
A bottom-up approach makes the difference
At Quoniam, we systematically uncover interesting investment opportunities by applying our factor investing approach. We evaluate single names in investment grade and high yield credit within dimensions like momentum, carry and value to create an advantage for our clients’ portfolios.
Benefits of Quoniam’s corporate bond approach:
• Diversified factors as alpha sources: value, momentum and carry
• Strict risk management to avoid negative surprises
• An optimised factor mix – including ESG
• Tight monitoring of liquidity/tradability