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Asset Managers Steer to Safe Territory Investment Grade Corporate Bonds in H2 Outlooks, as Covid-19 Clouds of Economic Reckoning Gather over High Yield Debt Borderlands

July 7, 2020

Major fixed income managers are clustering north of the border in the relative safety of investment grade corporate bonds as their favoured assets in market outlooks for the second-half of 2020, while they wait out the impact of the potential storm of Covid-19 economic reality gathering over the high yield debt border to the south.

“For now we remain constructive on investment grade, but go underweight on high yield again. Technicals rule but fundamentals might strike back. Be ready to buy once more,” Victor Verbeek, Co-head of the Robeco Credit Team said.

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James Stuttard, Robeco Credit Strategist, added that corporate debt levels are a concern and while companies have significantly increased gross leverage in the pandemic crisis, probably to hoard cash, reported earnings will be dismal in the next few months. This “double whammy” will increase leverage to new highs, he noted.

“With low yields stretching out over time, debt levels do not matter as much. But access to capital markets does. The refinancing hurdle is key. It seems that for investment grade credit, this hurdle has been partly removed by central banks. For high yield, though, fundamentals rule,” Suttard concluded.

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Europe’s largest asset manager Amundi echoed the sentiment that risky investments may have started their recovery too quickly, while economies remain fragile. Writing in Amundi’s second-half outlook, CIO Pascal Blanqué and vice-CIO Vincent Mortier warn: “The cycle can be disrupted by many factors, such as second pandemic wave risk, high debt, geopolitical risk and expensive valuations in some equity segments.”

“Once the catch-up of the cyclical part of the market is exhausted, the focus will return to corporate earnings. This could be a moment of truth, with some volatility,” they concluded.

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Fellow French asset manager Natixis IM was equally cautious and is maintaining an overweight position in higher quality U.S and European credit.

Esty Dwek, Natixis IM Head of Global Market Strategy Dynamic Solutions, said: “(We) remain more cautious on high yield as the extent of the damage from the crisis is still unknown and default risk remains. In addition, central banks are likely to favour protecting IG over HY, acting as a stronger backstop for the former. Spreads have already recovered a large part of the March widening and could consolidate for some time, but we believe they will continue to compress over the medium term.”

The world’s largest bond manager, Pimco, is also wary of the racy levels of debt among high yield issuers and is leaning towards investment grade, which, looking further down the road, portfolio managers Erin Browne and Geraldine Sundstrom conclude can provide attractive risk-adjusted returns in an economic recovery.

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“We favour companies that are positioned to deliver robust earnings despite a tepid macroeconomic environment. This approach emphasizes quality and growth in equity portfolios and ‘bend but not break’ investments in credit markets”, Pimco’s latest Asset Allocation Outlook advises.

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