Aller au contenu principal

Fixed income

Rethinking the role of investment grade corporates

The fixed income 40% – is now the time for investment grade corporates to take over from sovereign bonds? Senior Portfolio Manager Fatima Luis makes the case for an allocation switch-up.

Is it time for government bonds to step aside in favour of a new core portfolio allocation?

Summary

  • The classic approach to constructing a balanced portfolio is the 60/40 ratio.
  • Government bonds have been a core fixed income allocation, ranking low on the risk spectrum and typically considered a ‘safe bet’ for long-term returns.
  • But rising yields combined with geopolitical uncertainty, high inflation and the threat of recession means government bonds aren’t the obvious buy they once were.
  • What else should investors consider? Investment grade (IG) corporate bonds currently offer higher income and higher returns compared to developed market sovereign bonds.
  • We’re seeing price discrepancy in the asset class – A-rated IG corporates are trading at a price point associated with default scenarios.
  • While corporate debt won’t be immune from the impacts of recession, we believe quality IG credits should prove resilient and present a more attractive proposition compared to government bonds.

Download 'Rethinking the role of investment grade corporates'

Successful investing is all about getting your risk/reward balance right. The classic approach to constructing a balanced portfolio is the 60/40 ratio − 60% in equities to provide growth and 40% in bonds to deliver stable income and protect against equity volatility. Government bonds have been a core component of the fixed income 40%, ranking low on the risk spectrum and typically considered a ‘safe bet’ for long-term returns.

But today’s macro environment is delivering a unique combination of geopolitical uncertainty, high inflation, a shift from quantitative easing to tightening and the threat of recession. On top of this, we’re facing political disarray in the UK, with a revolving government rehashing policy and ramping up volatility across developed markets.

The result is the debt of many developed economies is a much less appealing portfolio stalwart than it has been historically. Yields on 10-year US Treasuries have increased from 1.5% at the start of the year to 3.6% today. In the UK, 10-year Gilt yields have gone from 0.9% to 3.4% (data to 28 October 2022).

If government bonds aren’t the obvious buy they once were, what else should you consider as a core portfolio allocation? Right now, we’re looking at high-quality, developed market corporate debt as an alternative.

Investment grade (IG) corporate bonds currently offer higher income and higher returns compared to developed market sovereign bonds. Combined, the yield and spread offer a buffer against rates volatility and recession risk. In a recessionary environment, government bond yields typically fall, providing an uplift to long-dated investment grade.

What IG corporates offer:

  • Spread – The Bloomberg US Aggregate Corporate Index’s average spread has nearly doubled from the low in June 2021 when it was at 80bps. At the end of October 2022, it was 158bps. If we discount the Covid-19 induced spike, this is a five-year high. This spread cushion should protect corporate credit from the volatile yield environment.

Bloomberg US Aggregate Corporate Index spread

Continuer vers

Ces articles peuvent également vous intéresser

Choisissez votre langue