€8.8bn poured into developed market corporate bond funds in June as expectation of rate cuts encouraged investors. Dippy Singh takes a closer look
European fund selectors have had a ferocious appetite for corporate bond funds in recent months.
There was a huge increase of the net flows into developed market corporate bonds in June 2019, according to Morningstar. Total net flows stood at €8.8bn, up from €1.09bn in May. The June 2019 flow trend is a world away from June 2018 when the net flow into corporate bonds stood at -0.2bn.
Source: Morningstar
The data show that investment grade corporate bond funds enjoyed something of a resurgence in June, but why?
In Europe, and, indeed, the US, the expectation of lower interest rates has been spurring investors to increase their exposure to corporate debt, compared to government debt.
Enthusiasm for corporate bonds is widespread among European investors. In an investment update to investors at the end of July, fund group Schroders said there were still plenty of good opportunities.
“We are positive as attractive short-term valuations offset longer-term concerns over fundamental credit quality,” the company said.
While Schroders’ investment team said that the company was now ‘neutral to US investment grade corporate bonds, European IG issuances were still of interest.
“We maintain a positive view as dovish statements and new appointments at the ECB have increased the likelihood that accommodative monetary policy will continue,” the team wrote.
Pan-European fund selector sentiment towards developed market corporate bonds has improved in recent quarters, according to Last Word Research.
Source: Last Word Research
High yield appeal
Elsewhere, the expected Federal Reserve rate cut, which eventually took place in July, seemed to have been the over-riding factor in prompting opportunistic investors to jump on high-yield US corporate bonds, with investors injecting $3.1bn into retail funds in the week ending June 26 – increasing from $602m the previous week , according to data from Refinitiv Lipper research.
Separate data from Bloomberg shows that 15 high-yield issuers sold nearly $10bn of new debt between the 22 and 26 June, including Charter Communications and Virgin Media.
In Europe, corporate borrowers have been upping their issuance of bonds as they enjoy lower borrowing costs and gained confidence from the return of US issuers. Companies issued about €108bn of ECB-eligible bonds this year, based on data from Bloomberg, with German and French borrowers issuing most of the new eligible notes.
Limited reward
Despite the enthusiasm for corporate bond funds, the number of investment grade issuances offering attractive yields has been falling still further. Figures from Tradeweb, released at the beginning of August, show nearly half (42 per cent) of European investment-grade corporate bonds are now negative yielding. The volume of these negative yielding bonds has been growing substantially over the past year, from less than a trillion Euros in July 2018 to 1.4 trillion Euros by July 2019.
This current trend in hoovering up corporate bonds, and overlooking the undesirable yields, also appears to be driven by fund managers playing ‘catch-up’ with the markets and their peers.
While many fund managers presumed that the hefty sell-off in December was indicative of the year to come, according to their market commentaries at the time, corporate bonds proved to be strong at the start of 2019. It meant that some fund managers missed out on the rally, because of an overly cautious investment approach. The resulting fear of missing out (and nagging doubts of playing it too safe) may offer another reason for the ongoing popularity of corporates.
In the bag
Earlier this year, luxury brand Louis Vuitton’s negative yielding corporate bond gained massive interest, with orders from fund managers being six times more than the bond’s EUR300m size, the Financial Times reported.
According to fixed income investment manager Pimco, while there are signs the corporate debt markets may be overheating, with issuance levels, underwriting standards, and structured product demand all evidencing signs of strong excess, corporate debt can be an attractive proposition for investors who have the stomach for the risks.
“Strategies that are less-correlated to the public debt markets or that seek to capitalise on economic weakness, market downturns, and idiosyncratic company issues can offer investors diversification within a fixed income allocation,” Neal Reiner, alternative credit strategist at Pimco explained.
“Opportunistic credit strategies are well positioned to invest during weak economic periods and in cyclical sectors. While investments can be structured with attractive terms and return potential, there can be elongation risk. In a prolonged downturn, some companies may be unable to refinance, thereby extending the holding period for lenders. Also, a prolonged downturn could create more challenges to earnings growth for companies, resulting in the need for additional capital to bridge them to an economic recovery.”
Reiner said for investors with longer-term strategies who can tolerate these threats, corporate debt can offer attractive opportunities for added return potential – possibly explaining why corporate debt is being looked upon favourably by some quarters.
While more investors wade into the sub-zero corporate bonds market to make up for possible missed opportunities, Pimco’s approach is keep a level head and concentrate on corporates that show signs of improvement. In terms of its own strategy, the fund manager focuses on financing companies that are currently challenged but have strong trajectories and asset values.
“The performance of these opportunistic strategies often relies on company selection rather than the beta of the public debt markets.
“[Our] mandate is broad, providing investors with exposure to capital solutions, as well as stressed, distressed, and idiosyncratic opportunities in both public and private markets. We thus aim to address the burden for investors to tactically rotate among strategies that focus on either performing credit or distressed credit,” Reiner commented.
