Vanguard, Wells Capital Call for a Corporate Bond Reality Checkby
Taking some money off table after 9.4% gains this year
‘Credit is challenged and ultimately has to reprice’
Some of the world’s biggest investors, including Vanguard Group Inc. and Wells Fargo & Co.’s asset management arm, are dialing down the risk they take in U.S. corporate bonds, even as central banks globally keep the money spigots on.
With just three months left in 2016, they want to lock in profits for the year and fear the relatively high valuations for investment-grade and junk debt from companies. The securities are trading close to their lowest yields relative to government debt in a year, Bloomberg Barclays index data show. Meanwhile S&P 500 companies’ earnings are falling and companies’ debt levels are high, which also make the bonds look less attractive. Money managers worry the current credit rally, buoyed by cheap money, won’t last long term without higher economic growth.
"We like credit less than we did in the beginning of the year when corporate bonds were a lot cheaper," said Greg Nassour, co-head of investment-grade portfolio management at Vanguard Group, which manages $3.8 trillion. The firm has been selling some bonds issued by industrial companies and buying safer debt from banks as well as asset-backed securities in recent months.
Other investors may be coming around to that way of thinking. Since the Federal Reserve last week scaled back its expectations for hiking rates next year and thereafter and the Bank of Japan said it was keeping 10-year rates near zero, investment-grade bonds have performed better than high-yield. Safer sectors like utilities have performed better than cyclical sectors like industrials, according to Bank of America Merrill Lynch index data.
Over most of this year, riskier company bonds have still performed better than safer debt. The shift in recent days may be a sign of how even as central banks are keeping financial markets awash in money, some investors wonder if risks are rising in markets. U.S. stocks fell on Thursday after a Bloomberg report said a number of funds that clear derivatives trades with Deutsche Bank have withdrawn some excess cash and positions and the financial sector fell.
U.S. investment-grade corporate bonds have risen 9.6 percent this year, including price gains and interest payments, according to Bloomberg Barclays index data. Junk debt is up around 15 percent over that same period. Both are performing better than the S&P 500 index, which is about 7 percent higher including dividends.
Valuations for company bonds look relatively high by at least one measure. An investor buying corporate bonds got around 1.38 percentage points more yield than from Treasuries on Thursday, close to one-year lows.
Some investors are still keen on the bonds. There are few better places to put money, with U.S. Treasury yields so low and U.S. equity valuations looking high, said Sean Taylor, the chief investment officer for Deutsche Asset Management in the Asia-Pacific region in an interview in Tokyo.
But a lot of the forces that lifted corporate bond valuations this year "are cooling off," said Ashok Bhatia, a senior portfolio manager at Wells Capital Management, which has around $340 billion of assets under management. Wells Capital has trimmed its holdings in investment-grade and high-yield corporate bonds that are sold by relatively risky companies like miners and oil drillers, Bhatia said.
"Owning a little bit less in corporate bonds makes sense, and having your holdings be a little bit more conservative in nature makes sense," Bhatia said.
In July, S&P Global Ratings said that a correction in credit markets was "inevitable" and "unavoidable," citing companies’ high level of debt and the fact that borrowings keep rising more. Earnings for the S&P 500 have fallen for five quarters.
Global economic growth is expected to slow to 2.9 percent in 2016 from 3.1 percent in 2015, Bloomberg data show. With weakening global growth and growing debt levels, the corporate bond rally lacks long-term support, said Randy Brown, who oversees $109 billion at Sun Life Financial Inc. in Toronto. He has been buying safer corporate bonds in less cyclical sectors.
It doesn’t make sense to abandon credit altogether, Bhatia said, because as long as the 10-year yield is low in Japan and central bankers in Europe keep buying corporate bonds, overseas investors will look for higher yields in the U.S. Many of those money managers, such as Japanese insurers, are likely to be risk averse and to favor safer securities, said Tom Murphy, a portfolio manager at Columbia Threadneedle Investments in Minneapolis, which has about $26 billion in investment-grade credit under management.
Still, there are reasons to be concerned about credit, Sun Life’s Brown said.
“The longer that rates are lower, the more risk there is at the other end,” said Brown, Sun Life’s chief investment officer. “Credit is challenged and ultimately has to reprice.”