With stock markets around the world selling of heavily in the coronavirus crisis, TwentyFour Asset Management’s Chris Bowie believes investment grade and high yield credit will outperform equities in the eventual recovery. 
While investment grade and high yield credit and have both experienced steep losses, Bowie believes it has led to a “once in a generation” levels of yields within the investment grade and high yield universe.
The manager gave an example highlighting that, in line with equity markets, the Coventry Building Society AT1 bonds (HY rated at BB), have fallen in cash price terms by 34 per cent, from 114 to 75.
Performance of sector and indices over 2020
Source: FE Analytics
However, he explained: “If you think Coventry must therefore be a high-risk bank, think again – its last reported Tier 1 capital ratio was 35.5 per cent. The main difference between credit and equity here is the yield of 14.7 per cent for this Coventry bond far eclipses the dividend yield on the FTSE 100.”
The TwentyFour Corporate Bond manager asked investors to question whether they will get that yield from equities, arguing that it is likely dividends will be cut as they were in the last two crises.
He also noted that the cumulative returns of the FTSE 100 including dividends has failed to beat retail price inflation over the past 20 years because of the index’s recent crash and it has actually been negative verses inflation for about 16 of the past 20 years.
UK equities and bonds vs RPI inflation
Source: TwentyFour, underlying data Bloomberg, iBoxx.
However, European high yield and UK investment grade credit delivered stronger returns, with both beating inflation for most of the past 20 years.
Bowie predicted that investment grade and high yield credit will recover much quicker than equities after this crisis is over, much like it did after the 2000 tech crunch and the 2008 global financial crisis.
As the chart shows, following the 2000 tech crunch, the recovery in high yield came through much quicker with high coupons from high yield bonds giving investors income sooner in the cycle and a capital recovery far more quickly.
By July 2004 European high yield investors had made back their losses while equity investors had to wait until 2006 to get the hypothetical £100 they had invested on 1 January 2000 back.
After the 2008 global financial crisis, higher coupons and earlier income in the recovery period also gave high yield investors stronger returns than the equity market.
By October 2009 high yield investors were back above inflation in cumulative terms again, while equity investors had to wait another four years, by which point high yield generated an additional 50 per cent over and above equities.
“Even if an investor had bought equities at the previous lows, with perfect timing, they still would not have outperformed credit”, he argued.
Bowie said that during the global financial crisis, the banks who were over leveraged had to recapitalise after their bailouts to capital ratios of those three to four times higher than what they were in 2007. This resulted in far less operational leverage, and thus returns to equity holders, with their equity looking more like utility rather than growth.
He expects a similar thing to happen the non-financial companies that have issued high levels of debt. Post-crisis, these companies will likely have to ensure higher liquidity buffers, less operational leverage and ultimately more utility-like cash flows to investors.
“This is why we do not think equities are a buying opportunity when you can buy investment grade and high yield credit at some of the cheapest yields we have ever seen,” the manager said.
What’s more, he argued that credit will benefit from the unlimited quantitative easing announced by the Federal Reserve and the stimulus announced by the Bank of England.
He believes the measures such as the Primary Market Corporate Credit Facility (PMCCF) and Secondary Market Corporate Credit Facility (SMCCF) are expected to provide bridge financing to make sure coupon and principal repayments are met, contrary to dividends which are discretionary.
“Ultimately, we believe credit will continue to outperform equity for many years to come” he said.
Performance of fund vs sector and index since launch
Source: FE Analytics
Bowie has managed the TwentyFour Corporate Bond fund since launch in January 2015, over which time it has made a total return of 18.42 per cent against the 13.41 per cent from the average IA Sterling Corporate Bond peer. It has a yield of 3.88 per cent and an ongoing charges figure (OCF) of 0.35 per cent.