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Global Corporate Bonds New Opportunities – Payden & Rygel

Amanda Cheesley

1 May 2024

Doubt lingers around the global corporate fixed income sector, but Natalie Trevithick, head of investment grade credit strategy at , urges investors to believe in the sector.

Yields are high – around 4 per cent in euro-denominated bonds and over 5 per cent in US and sterling issues, Trevithick said in a note. Central bank cuts have so far failed to materialise, keeping rates attractive for now, especially at the long end, she added. 

“Duration is your friend. So, while global central bank cuts may have been pushed back further in 2024, we still expect them to come and, in the meantime, you're clipping a nice coupon,” Trevithick continued. “Even if we only get two to three rate cuts in the year ahead, we're looking at total returns in the high single digits. If we're pushing out the rate-cutting cycle further, that sets us up nicely for 2025, 2026 with nice solid returns, you want to have that longer duration component within your portfolio.” 

Three key factors drive performance
The team highlighted that three key factors drive global corporate bond returns, namely fundamentals, technical factors, and valuations.

Fundamentals are strong as corporate issuers are benefiting from the stronger-than-expected global economy, the team said. Corporate issuers locked in lower borrowing costs prior to 2022 by issuing longer dated bonds with the proceeds going toward paying down shorter maturity bonds. As a result, interest costs remain historically low for corporate borrowers, even after the run-up in rates. The average coupon on the global investment grade corporate index is now just under 3.75 per cent, the team added.  

Margins are strong, given still higher-than-normal inflation in the US and Europe. Leverage is relatively low, declining in Europe and stable in the US, as investors have been exercising prudence with their capital structures. 

Technical factors
The team believes that technical factors look even better as investors are putting money into fixed income assets to capture the attractive level of yields. On the supply side of the equation, issuers would prefer not to issue debt at these high levels of yield. “So, there's very much a stronger demand than there is supply,” Timothy Crawmer, director and global credit strategist, said.

Supply has been slightly increasing in the US lately, as issuers refinance at lower spreads, and merger and acquisition activity generates more new issues. However, the team believes that demand is strong enough to offset this increase. “In 2024, inflows have been robust across the spectrum, and we've seen investors attracted back into fixed income due to the higher yields against the backdrop of falling inflation. The inflows into investment grade corporates have been enough to soak up the supply. We expect this trend to continue this year and technicals to continue to be a strong positive force for returns in the global investment grade (IG) corporate markets,” Frasat Shah, a senior vice president in global fixed income, said.

Meanwhile valuations are fair, even given the decline in spreads amid heightened demand. “When we look back over time, there have been periods where valuations have been even tighter from a spread perspective when fixed-income demand was elevated like it is today,” Crawmer added. 

Despite an overall positive environment, Payden’s team said it identified some risks which it is tracking closely. As borrowing costs increase, default risk increases, so Payden has been focusing on liquid, higher-quality corporates globally. 

Idiosyncratic credit risk – that is factors that affect only one issuer – becomes more crucial in a tight spread environment. Payden said it protects against this type of specific risk through broad diversification across securities. 

External risks, including the Covid crisis, the Ukraine war and the UK pension crisis, have affected corporate bond markets in recent years. These events are by their nature hard to predict. Payden said it works with its risk department to run scenario and stress test analysis to understand how its global corporate portfolio would perform in unexpected risk environments. 

Liquidity squeezes are another risk, as in the run set off by the UK pension crisis. Payden said it protects against this risk by maintaining liquid portfolios and working with trading counterparties to ensure effective execution.

Investment grade versus high yield
Paydn believes that the case for investment grade corporates is somewhat stronger than for high yield bonds for two reasons. First, the high yield market has become fragmented, with higher quality issues trading near historically tight spreads, while lower rated issues are less richly valued. The opportunities for price appreciation, then, are in the riskier end of the market, the team said.  

Second, high yield has an average duration of three to four years, much shorter than the investment grade asset class. As a result, these bonds don’t benefit as much from interest rate cuts and a move lower in government bond yields as investment grade bonds do, the team continued.   

The case for diversifying into global corporate bonds 
Trevithick said that the argument for diversifying a portion of the global fixed income portfolio from sovereigns into corporates is simple: excess return potential. 

“Last year and year-to-date, one- to 30-year US corporates provide 80 basis points in incremental yields. Global corporates offer around 50 basis points. So, there's still good excess return to be had just with that incremental carry, especially when we view it to be relatively low risk,” Trevithick added. “Even if we get a little bit of volatility, and we'll see spreads widen out, as long as you have the conviction to carry your portfolio throughout these periods of volatility, we think you'll get that nice excess return in the end.” 

Payden & Rygel, a large privately-owned global investment advisor, focuses on the active management of fixed income and equity portfolios, providing a range of investment strategies and solutions to investors globally including central banks, pension funds, insurance companies, private banks, and foundations. It has offices in Los Angeles, Boston, London, and Milan.