The year ahead is a “coupon clipping” one for corporate bonds, according to Kris Atkinson, a portfolio manager at Fidelity International.
All-in yields in sterling corporate bond markets remain attractive, he says, citing a yield to maturity of 5.6 per cent that compares favourably to history and across asset classes.
“For long-term investors seeking defensive income options, the yield on corporate bonds offers an attractive proposition.”
Even so, Atkinson highlights that the risk-free rate makes up the bulk of the all-in yield.
“10-year gilt yields are 4.6 per cent, leaving the credit spread at 1 per cent. To put that spread into context, our quantitative screens show that spreads have been lower than this just 9 per cent of the time since 2006.
“At the same time, our screens also show that while spreads are low, investment-grade credit spreads at these levels still compensate investors even for a meaningful pick-up in defaults; however, the same cannot be said of high-yield corporate bonds.
“We therefore have a preference for investment-grade over high-yield bonds at this stage.”
On balance, it is unlikely spreads will be tighter in 12 months’ time, he adds.
Mark Preskett, a senior portfolio manager at Morningstar Wealth, likewise says it is impossible to ignore the fact that credit spreads are tight across the corporate bond universe.
“Yields are high relative to history, but credit spreads have compressed to very low levels.” But for Preskett, this materially lowers the attractiveness of the investment opportunity.
“In the UK, credit spreads are . . . well below historical averages, and represent a risk. In addition, we are not seeing much difference in terms of geography; credit spreads are tight across investment grade, whether issued in dollars, euros or sterling.”
Credit analysis and selection ‘crucial’
Given the tightness of credit spreads, alongside the more difficult funding environment for the corporate sector by way of higher borrowing costs, Atkinson says fundamental credit analysis will be crucial to navigating the period ahead.
Among other things, credit analysis may involve examining a borrower’s financial statements, its industry, the quality of management, any collateral securing the bond, and the bond documentation.
“This helps to build a fundamental picture of the issuer’s creditworthiness, which needs to be compared to the value on offer. For investment-grade corporate bonds, this is most commonly assessed via the credit spread.”
Atkinson adds: “The key is trying to find bonds that offer slightly more value than is being discounted by the market, and to avoid bonds where the market is placing too high a price on the underlying cash flows.”