The U.S. Corporate-Bond Trade That’s Beating Equities This Yearby
Long-dated corporates perform better than equities, junk
Average maturity has doubled for U.S. companies’ new issues
Last year, corporate bond fund managers feared the Federal Reserve. Now they fear low returns even more.
Investors including Loomis Sayles and Franklin Templeton are piling into longer-term company debt, the securities that offer the highest coupons but also suffer the most when yields rise. Company bonds maturing in 15 years or more are among the best performing assets of 2016, up more than 12 percent this year, according to Bank of America Merrill Lynch data. That return is clobbering three- to-five year company notes, which gained just 3.87 percent, and the S&P 500, which rose 2.94 percent. It beats even junk bonds’ 8.32 percent gains.
Investors’ intense demand for long-dated bonds underscores how much less concerned they have grown about hikes as the Fed meets today and tomorrow to discuss rate policy. After a government report on June 3 said that employers added the smallest number of workers to their payrolls in May in almost six years, market participants see no chance of an increase on Wednesday, and just a 15.7 percent chance of a hike in July. In early January, those futures forecast a 73.3 percent chance of a hike on June 15.
Even when the Fed does resume hiking rates, yields are below zero for more than $8 trillion of bonds globally, and investors are more willing to take on the added risk of holding longer-term bonds to earn higher returns. Yields on Japanese government bonds maturing in 40 years, for example, fell to record lows on Tuesday. Germany sold 10-year bunds with a record low yield of 0.01 percent on Wednesday, a day after the yield on the nation’s 10-year went below zero for the first time.
"Long-term bonds are one of the few remaining places that investors can get some yield,” said Jeff Cucunato, head of U.S. investment-grade credit at BlackRock Inc., the world’s largest asset manager.
During Fed tightening cycles in the 1990s -- and again in 2006 -- prices for longer-term securities fell more than those for shorter-dated debt. Last year, U.S. corporate bonds maturing in 15 years or more were some of the worst performing fixed-income securities, losing 5.3 percent.
Now, investors are betting that even if short-term rates do rise, prices for longer-term bonds may not suffer much, in part because inflation fears are so low. The gap between short- and longer-term bond yields has been shrinking in the U.S. and around the world.
Earlier this month Aetna Inc. sold $2.4 billion of 30-year bonds as part of its $13 billion debt offering to fund its acquisition of Humana Inc. The 30-year portion was among the most oversubscribed parts of the deal, which got $45 billion of orders, according to Todd Mahoney, head of fixed income syndicate Americas at UBS Group AG, one of the managers of the sale.
Last week, Apple Inc. sold $1.38 billion of 30-year bonds in Taiwan. And Microsoft Corp. is likely to sell long-dated debt when it finances its $26.2 billion purchase of LinkedIn Corp., an acquisition announced on Monday, said Jordan Chalfin, an analyst at CreditSights.
U.S. companies have broadly been taking advantage of investor demand for longer-term bonds. In 2015, the average maturity of U.S. corporate debt that was issued was more than 17 years, nearly twice the average from 1996 to 2006, according to the Securities Industry and Financial Markets Association, a trade group.
That has left the bond market as a whole riskier. If short- and long-term bond yields rise unexpectedly by 1 percentage point, investors in U.S. bonds of all varieties, including corporate and government debt, could lose around $1 trillion, analysts at Goldman Sachs estimated in a report earlier this month. Those figures are far worse than prior rate hiking cycles, because there is so much more debt of all types, and because so much of that borrowing is longer dated, the analysts said.
Longer-term corporate bonds have more interest-rate risk, and more credit risk too. A company can make many decisions over decades that harm debt investors, said Mark Kiesel, chief investment officer for credit at Pacific Investment Management Co.
“We’re screening a lot of these investments,” Kiesel said. “When you lend to a company for 30 years, you have to take a much longer-term view.”
Still, when Dell sold $20 billion of debt last month to finance an acquisition, it neatly illustrated why investors are willing to take risks with longer-term debt. The 30-year bonds it offered have a coupon of 8.35 percent, more than double the coupon on the three-year notes.
“We’re still seeing value” in long bonds, said Neil Burke, a money manager at Loomis Sayles & Co., which manages about $229 billion in assets. Negative short-term rates in Europe and Japan have spurred many investors to look to the U.S. for higher yields.
Longer-term bonds may perform well whatever the Fed does, said Marc Kremer, a money manager at Franklin Resources Inc.’s Franklin Templeton Investments unit, which manages $747 billion. Franklin Templeton is keeping the duration of some its portfolios shorter than their indexes to protect them from rising rates, but it’s adding longer-dated debt selectively because the values are attractive.
“Even if the Fed is going to be aggressive, it doesn’t necessarily mean the 10- to 30-year yields might increase significantly as well,” he said.