The hunt for yield has been exacerbated by the Covid-19 pandemic or, more specifically, the policy response to the pandemic. Interest rates have been cut to historic lows in many developed countries, and governments have been spending huge amounts of money to keep economies alive during lockdown amid the Covid-19 crisis.
But it has had consequences for investors. Yields on perceived safe-haven government bonds have been driven to all-time lows. In some cases they are in negative territory. That means you’re in the seemingly crazy situation of actually paying governments for them to borrow money from you.
The fall back for yield-hunters has mostly been the stock market, where company dividends have been substituted in to pick up the slack from lacklustre bond yields.
But even in stock markets there is uncertainty. Many companies have either had to cut their dividends amid collapsing revenues or been forced to withhold them by regulators to preserve their balance sheets.
So where else can you look? Global corporate bond – also known as credit - markets , have proven popular.
The credit market refers to the market through which companies and governments issue debt to investors, such as investment-grade bonds (higher quality debt) and high-yield bonds (lower quality, riskier debt).
It is a huge market. If you have a pension you will undoubtedly have exposure to credit markets in some fashion and similarly if you own certain types of index trackers.
Like stocks, there are certain parts of the credit market that have performed better than others since the pandemic began.
We spoke to Julien Houdain, Deputy Head of Credit Europe, who talked us through three things credit investors should consider in the coming months.
1. The pandemic is not going away and neither are low rates
“Unfortunately the pandemic isn’t going away. As a result, economies have struggled. To combat the downturn we have seen huge amounts of monetary and fiscal stimulus, the likes of which we have not seen before.
“For instance, since March global central banks have averaged $1.4 billion of asset purchases every hour, that is according to data from Bloomberg.
“Governments have come to the party too with fiscal schemes, such as furloughing employees, to support people unable to work during lockdown. But it has created a record high deficit – the $258 trillion of global debt now accounts for 280% of global GDP.
“We have the problem where there is too much debt in the system. Debt is not a bad thing providing you can create growth. It is just that globally we haven’t been able to create that growth. It is a trap. The only solution we have is to pump more debt into the system.
“Governments and central banks have done a great job of saving the economy, but it remains on life support. To judge where we are going to be in six months time you have to make broad assumptions.
“Markets are confident that even if fiscal policy fades central banks will do a lot more. That might mean that even if things are getting worse from a global perspective, credit markets might see some positives. This is because central banks might extend their support of corporate bonds - both those classified as “investment grade” (lower risk, high quality) and non investment grade (higher risk, lower quality bonds known as high yield) - and even of equities.
“The one thing that could change the market is the creation of a vaccine. This could mean current winners become losers and vice-versa.
2. Asia, China, Brazil and Mexico present opportunities but tread carefully
“Overall, there is a hunt for yield. Investors will be pushed into high yield and emerging markets. And it is important to find the areas of these markets that will suffer less in case of a downturn.
“The investment grade market in Europe should be safer and see less volatility than the US. In Europe, confidence around fiscal support will be higher than the US. Cheques stopped being sent out to furloughed workers in the US in July and the upcoming election is causing uncertainty as to whether there will be any more support.
“If you go into the high yield part of the market, which is riskier, then you need to be more careful and do the work company by company, sector by sector. There is still a lot of dispersion in valuations.
“Emerging markets are more interesting. There is still some value among corporates there particularly in Brazil, where external dollar debt (i.e. debt owed to non domestic lenders) is low, and Mexico. But government debt in both those countries is not as cheap as it was in May and June, and they are not in the best position if we see a downturn.
“Asia is interesting and China in particular. They have managed the pandemic much better then Europe and the US. Yields are still high and there is still a lot of value in the high yield market. Also, if we see global reflation it will begin in Asia and China.”
3. Covid-hit bonds look like bargains, but come with risks
“If we take a look at opportunities at the sector level, residential real estate and banks exposed to home loans are interesting. For instance, we have seen in the UK that mortgage lenders have been doing a roaring trade since the end of lockdown.
“Digitalisation has been a theme for a while and there has been some nice stories surrounding certain online retailers in the UK. And of course, more generally, the streaming platforms where Covid has accelerated their demand.
“Environmental, social and governance factors (ESG) are a big theme too. Lots of companies are issuing green bonds. But in the future it could be a problem for tobacco. You get relatively high returns from the sector but you have to think longer term: how difficult it will be for tobacco companies to refinance if ESG becomes an important factor?
“Elsewhere, there are some bargains to be had by investing in Covid-affected names and their potential recovery.
“For example, those areas most affected by Covid-19, such as consumer sectors like airlines, hotels and restaurants are trading with pretty huge premiums, offering considerably higher yields than the rest of the market”.
“But they are cheap for a reason, because most of them are on life support. These companies will be affected by more people working from home and fewer people travelling. It is key to understand these trends because life won’t just go back to normal.
“At the moment you might prefer the platforms that help you book trips, hotels or restaurants rather than chains themselves.
Julien was speaking on the Investor Download, part of the Schroders podcast network.
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