{"id":31372,"date":"2022-08-02T15:40:56","date_gmt":"2022-08-02T15:40:56","guid":{"rendered":"https:\/\/www.quoniam.com\/?p=31372"},"modified":"2022-08-05T08:42:50","modified_gmt":"2022-08-05T08:42:50","slug":"how-attractive-investment-grade-credit","status":"publish","type":"post","link":"https:\/\/www.quoniam.com\/en\/article\/how-attractive-investment-grade-credit\/","title":{"rendered":"How attractive is investment grade credit?"},"content":{"rendered":"\n
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In the article \u201cHow do government and corporate bonds fare in a stagflationary environment?<\/a>\u201d we analysed how to position oneself as an investor who expects a longer-term stagflationary environment similar to that of the 1970s. However, the market now also sees another scenario as likely, with a declining inflation rate and increasing recession concerns. How sensible is it to invest in investment grade corporate bonds in such an environment?<\/p>\n<\/div><\/div>\n\n\n\n

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Difficult market environment in the first half of 2022<\/h5>\n\n\n\n

Driven by high inflation rates, interest rates rose sharply on both sides of the Atlantic, while risk premia for corporate bonds were driven up sharply. Accordingly, the realised returns for an investment grade credit investor were negative by double digits in the first half of 2022, regardless of whether the investment was made in Euro, Global or USD investment grade credits. Losses of around 12% were incurred with European corporate bonds, by far the worst return ever achieved since the introduction of the euro.<\/p>\n<\/div><\/div>\n\n\n\n

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Figure 1: Annual returns for euro investment grade credit since Euro introduction<\/h5>\n\n\n\n
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Source: Bloomberg L.P., Quoniam Asset Management<\/figcaption><\/figure>\n\n\n\n
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Yields have become attractive<\/h5>\n\n\n\n

This increase in risk premiums and interest rates has pushed the yield level of corporate bonds to a significantly higher level. The yield of the Bloomberg Aggregate Euro Corporate Index rose to 3.19% at the end of the first half of 2022 and recently traded slightly below 3%. Around 1% came from the interest rate side and a good 2% from the credit side. An actively managed euro investment grade credit portfolio can currently earn a return of between 3% and 3.5%, which corresponds to the return requirements of many institutional investors.<\/p>\n\n\n\n

The total return expectation is even higher than the current return, since in addition to the interest due to the steepness of the curve, a rolldown return can also be collected. In the case of an increasing yield or spread curve, an additional return arises from the fact that bonds fall to lower yield levels (and thus rise to higher prices) due to their shortening residual term over time. Taking this rolldown effect into account, current expected returns are 3.7% for the euro investment grade benchmark and over 4% for actively managed portfolios.<\/p>\n\n\n\n

The yields for global and US investment grade credit are somewhat lower due to the currently high hedging costs. This may change dynamically in the event of a convergence of key interest rates in the USA and the eurozone. Due to the current figures, we focus on euro investment grade credit in this analysis.<\/p>\n<\/div><\/div>\n\n\n\n

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Figure 2: Total return expectation for euro investment grade credit<\/h5>\n\n\n\n
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Source: Quoniam Asset Management<\/figcaption><\/figure>\n\n\n\n
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Credits have also become more attractive compared to other asset classes<\/h5>\n\n\n\n

Currently, corporate bond yields appear attractive, as a comparison with other asset classes also shows.<\/p>\n<\/div><\/div>\n\n\n\n

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Figure 3: Yields of different asset classes<\/h5>\n\n\n\n
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Source: Intercontinental Exchange, Inc.; Bloomberg L.P.; Quoniam Asset Management<\/figcaption><\/figure>\n\n\n\n
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As can be seen from the figure, the current yield of euro investment grade corporate bonds is now at a similar level to that of other asset classes. If daily fluctuations in the markets are excluded, the following conclusions can be drawn:<\/p>\n\n\n\n