{"id":66467,"date":"2017-10-19T07:19:21","date_gmt":"2017-10-19T05:19:21","guid":{"rendered":"http:\/\/beta.next-finance.net\/opinion\/corporate-bond-opportunities-in-a-late-cycle-market\/"},"modified":"2019-12-31T02:13:53","modified_gmt":"2019-12-31T01:13:53","slug":"corporate-bond-opportunities-in-a-late-cycle-market","status":"publish","type":"post","link":"http:\/\/beta.next-finance.net\/en\/opinion\/corporate-bond-opportunities-in-a-late-cycle-market\/","title":{"rendered":"Corporate bond opportunities in a late-cycle market"},"content":{"rendered":"

At this stage of the economic and credit cycle we remain
\nreasonably constructive about the prospects for the global
\ncorporate bond market but are taking a more defensive
\napproach than a couple of years ago.
\n
Global corporate portfolios offer issuer and security selection
\nalpha potential over and above that found in US Dollar, Euro
\nand Sterling only funds<\/strong> <\/em><\/p>\n

THE DEBT-EQUITY CLOCK IS TURNING<\/strong><\/p>\n

In the years that followed the global financial crisis credit investors benefitted from a period of
\nimproving credit fundamentals. Companies and banks strengthened their balance sheets and more
\nrecently have delivered rising profits. As we head into the second half of this year there can be little
\ndoubt that this cycle has turned. These turning points are often to the detriment of bond holders.<\/p>\n

There are more examples of companies re-leveraging and directing cash flows to the interests of
\nshareholders in the form of dividends or share buybacks, where previously they were employed
\nto improve balance sheets and reduce debt.<\/quote>
\n Earnings are often being used to fund expansionary
\nmergers and acquisitions and examples of speculative bids are increasing. In the last year AT&T
\nmoved in for Time Warner, British American Tobacco for Reynolds American and Kraft Heinz tried to
\nacquire Unilever. Although the last deal did not actually complete, it forced the acquiree to re-leverage
\nand send more of its cash back to shareholders. As a result global corporate leverage has increased
\nover the last few years despite strong earnings, which is classic late-cycle behavior.<\/p>\n

DEMAND FOR INCOME WITH SOME SAFETY REMAINS
\nA POWERFUL FORCE<\/strong><\/p>\n

The supply of new corporate bonds has been robust this year reflecting the behaviour of corporates
\ndescribed above. However this is only one side of the coin. Demand from a cross section of investors,
\nboth retail and institutional, has also remained heightened both in the US, in Europe and the UK, with
\ncentral banks having reduced interest rates to near zero and having pursued expansionary policies
\nthat include the purchase of bonds in general and corporate bonds in particular. Hence we view the
\nstructural background as supportive for the market.<\/p>\n

MARKET VALUATIONS LOOK REASONABLE<\/strong><\/p>\n

The spread we receive for investing in corporate bonds has reduced meaningfully since the start
\nof last year and it is tempting, therefore, to view the market as overvalued.
\nHowever in the historical
\ncontext of the last 10 years corporate spreads are actually fairly close to average.<\/quote> <\/p>\n

Figure 1: Global corporate bond spreads \u2013 last 10 years<\/strong>
\n\"spreads_des_obligations_d_entreprises_mondiales_-_10_dernieres_annees.jpg\"<\/a><\/p>\n

HOW WE MANAGE PORTFOLIOS<\/strong><\/p>\n

Within our own investment grade portfolios, we seek to deliver attractive long-term risk-adjusted
\nreturns, using a consistent, disciplined and active approach focused on individual issuer and
\nsecurity selection. Our decisions are informed by rigorous, independent, bottom-up fundamental
\ncredit research. A team of 15 investment grade analysts dedicated to this area of the market use
\na proprietary approach which results in a deep understanding of issuer and industry dynamics.<\/p>\n

Each analyst researches around 30 issuers, with in the region of 470 companies assessed by the
\nteam as a whole. The research team provide performance recommendations, ratings based on
\nforward-looking credit quality expectations and a risk score for each company. They then work in
\ncollaboration with a team of six portfolio managers on investment decision-making and portfolio
\nconstruction.<\/p>\n

The investment grade team are also able to leverage the wider resources of the Columbia
\nThreadneedle Investments\u2019 fixed income and equity groups, giving us insights into all major fixed
\ninterest asset classes and geographies. We believe this cross-fertilization of ideas enables a deeper
\nunderstanding of industry issues and provides the portfolio management teams with a well-informed
\ninvestment perspective as they make relative value assessments.<\/p>\n

SHIFTING OUR ALLOCATIONS AGAINST THIS BACKGROUND<\/strong><\/p>\n

So, where are we finding the most attractive opportunities now, and how are we positioning our
\nportfolios in this late stage in the credit cycle? It is now just over three years since we launched the
\nThreadneedle (Lux) Global Corporate Bond Fund. The evolving nature of the portfolio\u2019s construction
\nsince launch gives a practical insight into our thinking.<\/p>\n

When we launched the fund in June 2014, banks were a big theme in the portfolio. At the time, banks
\naround the world were still being forced by regulators to build capital, improve liquidity and run down
\nbad assets. This trend has largely come to an end. This does not, of course, mean we are predicting
\nanother banking crisis since banks are now in sound shape in most countries. <\/p>\n

However, the direction
\nof travel with respect to credit quality has turned at a time of less attractive valuations and this has
\nled us to take a more neutral view on the banking area of the market as a whole. At an industry level,
\nas the credit cycle has matured, we have moved more of the portfolio into more defensive, less
\ncyclical sectors such as regulated utilities. Presently, for example, around a quarter of the risk in the
\nportfolio is now achieved through investments in regulated utilities and infrastructure issuers.<\/p>\n

CONCLUSION<\/strong><\/p>\n

The credit cycle is certainly turning and corporate bond spreads are somewhat less attractive than
\nthey were 18 months ago. However investor demand remains robust and the ongoing provision of
\nultra-loose monetary policy means that corporate bonds will remain a cornerstone of investors\u2019
\nportfolios for some time.<\/p>\n

We have adjusted the construction of our portfolios to reflect this new reality but remain reasonably
\nconstructive about the prospects for the asset class into the end of this year.<\/quote>
\n