Corporate bonds have had a “terrific year,” with low double-digit returns for investment grade and slightly lower for high yield, says Ignacio Sosa, director of international relationship management at DoubleLine Capital in Los Angeles, Calif.
However, a lot of these returns are driven by falling interest rates, he said in an Oct. 16 interview, and this sensitivity to interest-rate movements makes corporate bonds risky.
“The sensitivity of investment-grade corporates to U.S. interest rates is particularly concerning because the spread that this universe has relative to [the] U.S. Treasury is relatively low,” Sosa said. “It’s around 120 basis points, which means that you get paid about 120 basis points more to buy an investment-grade corporate bond versus a U.S. Treasury. That sounds to us to be relatively tight.”
And since the duration is around seven years for the market to roll, “the cushion that’s provided by the spread is pretty low in the event that rates go up,” said Sosa, whose firm manages the Renaissance Flexible Yield Fund.
In the event of a recession, which Sosa puts at around 50%, corporate bond spreads are likely to go up.
“To have an asset class like investment-grade corporates that has a very high sensitivity to interest rates and a relatively low credit spread in a situation where one expects a 50-50 chance of a recession doesn’t sound like a good risk proposition,” he said.
Additionally, corporates are at “record highs” in terms of issuance and debt, Sosa said. “Tight prices for investment-grade corporates, huge supply, [and] a 50-50 chance of recession would not make us comfortable that this was an asset class that we would want to overweight.”
However, there are alternatives to corporate credit, he said. With the U.S. consumer supported by a strong labour market and continuing to spend, other credit market opportunities include non-guaranteed mortgages, commercial mortgage-backed securities, asset-backed securities, collateralized loan obligations (CLOs) and U.S.-dollar-backed emerging market debt, he said.
“The fundamentals that underpin many of these, particularly in the housing market, seem relatively strong compared to other sectors,” he said.
“We think all of these have better value than the corporate bonds,” he said. Some options, such as CLOs, have low sensitivity to interest rate movements, he added.
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