The slowing debt cycle, tighter credit spreads and reduced central bank support had already led to us taking a rather cautious and neutral view on the corporate bond universe. There has, however, been some additional deterioration in fundamentals in the US investment-grade credit segment, as leverage levels remain relatively high (and are higher than Euro IG for the first time in 10 years). Furthermore, the credit quality of the US IG segment also continues to deteriorate. Finally, the effect of the US corporate tax reform is difficult to gauge at this particular juncture as a result of the lack of details and of the high execution risks. With valuations that are no longer attractive, and with roughly 4.7 trillion set to mature between now and 2022, we are cautious on the US IG asset class and aim to hold an underweight position in it. We have also added CDX indices to our global bond funds.
Euro IG credit, while relatively tight in terms of spreads, exhibits strong company results and improving ratings. It is also important to note that non-Eurozone companies’ share of issuance in Euro IG has increased (to roughly 40%), making it a less “domestically dominated” asset class, as foreign companies aim to take advantage of easy financing in the euro area. Additionally, technical factors continue to support the asset class, with a significant level of debt that needs to be refinanced over the next 3 years (roughly 1 trillion) and a continually strengthing demand.
European financial credit favoured; CoCos still instrument of choice
We continue to overweight the financial sector vs. the non-financial sector, which is currently benefiting from better fundamentals and relatively attractive valuations (though spreads, narrowing rapidly, are at low levels). The financial sector is also supported by improving capital reserves (and asset quality), better margins (on the back of rising interest rates) and the regulatory landscape. Within the financial sector, CoCos remain our instrument of preference, benefiting, as they are, from earnings recovery, lower duration, and a weaker correlation to US Treasuries. In terms of yield, these instruments match the levels presented by US high-yield credit.