Are corporate bonds a good bet?
Corporate bonds pay a slightly higher yield than governments, but spreads aren’t generous by past standards.
In recent updates, I’ve looked at the role of government bonds in the MoneyWeek exchange-traded fund (ETF) portfolio. Next, I’ll move on to review our equity positions. But first, let’s talk briefly about corporate bonds.
These aren’t a core part of the strategy, because they don’t generally add much. Conventional government bonds offer a safe haven. Inflation-linked bonds promise a guaranteed real return. Both reduce risks. Corporate bonds add credit risk: they pay higher yields than government bonds, but you lose part of that if some default.
Over the past 50 years, US corporate bonds have beaten ten-year Treasuries by around 1.2 percentage points per year. Equities have done a lot better. So we’d rather take our risks in equities.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Of course, if corporate bonds were unusually cheap relative to other assets, they would become more attractive. Over most of the past decade, with yields heading ever lower, that was never the case. Yields today are higher – but so are yields on government bonds. The spread between the two has not expanded to an extent that makes corporate bonds look exceptionally compelling.
Credit spreads vary depending on the borrowers’ credit rating. For example, the spread for ICE BofA AAA US Corporate index (ie, top-rated borrowers) currently stands at 0.44 percentage points (pp). The spread for BBB borrowers, the lowest investment-grade rating, is 1.55 pp. Some groups are a bit higher relative to history than others, but none look generous.
The chart below shows a near three-decade history for a composite index of US corporate bonds of all ratings. This is probably a fair overall summary and shows the current spread is a little below the average over this period. Note also that after many years of low rates, many companies are carrying plenty of debt. Some will struggle as they need to refinance this on higher yields. Defaults are likely to rise – they are already ticking up.
All told it’s hard to feel that today’s spreads offer extra compensation for the risks. So there is little obvious opportunity here for the portfolio at present.
Fallen angels and higher yields
Perhaps the most interesting area for us is fallen angels – bonds that have been downgraded from investment grade to junk. Since some investors are forced sellers in this situation, these often trade cheaper than their fundamentals would justify.
Over the long term, fallen angels have outperformed corporate bonds as a whole. Anomalies like this can be a useful way to add value. With fallen-angel indices now yielding around 8%, they look a little tempting. There are a handful of ETFs in this area such as iShares Fallen Angels High Yield Corp Bond ETF (LSE: RISE). However, spreads on fallen angels are still tight compared to history, while this particular ETF has lagged its index by more than I’d expect over the past five years. I will be looking at this sector closely as the credit cycle turns – but I’m not yet convinced this is the time or way to invest.
This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.
Related articles
- Is it a good time to buy bonds?
- Is it time to buy gilts?
- Happy days are here again for equity investors
Sign up to Money Morning
Our team, led by award winning editors, is dedicated to delivering you the top news, analysis, and guides to help you manage your money, grow your investments and build wealth.
Cris Sholto Heaton is an investment analyst and writer who has been contributing to MoneyWeek since 2006 and was managing editor of the magazine between 2016 and 2018. He is especially interested in international investing, believing many investors still focus too much on their home markets and that it pays to take advantage of all the opportunities the world offers. He often writes about Asian equities, international income and global asset allocation.
Cris began his career in financial services consultancy at PwC and Lane Clark & Peacock, before an abrupt change of direction into oil, gas and energy at Petroleum Economist and Platts and subsequently into investment research and writing. In addition to his articles for MoneyWeek, he also works with a number of asset managers, consultancies and financial information providers.
He holds the Chartered Financial Analyst designation and the Investment Management Certificate, as well as degrees in finance and mathematics. He has also studied acting, film-making and photography, and strongly suspects that an awareness of what makes a compelling story is just as important for understanding markets as any amount of qualifications.
-
Higher rates are disappearing – should you fix your savings?
Fixed savings rates have dropped to their lowest levels in over a year. Should you fix your savings now ahead of a potential base rate cut in November?
By Katie Williams Published
-
Nine million people fall victim to financial scams, says Citizens Advice
The charity says that around one in five people across the UK have been caught out by a finance scam in the past year - here is how to protect your money
By Chris Newlands Published
-
What will a broken-up Google look like?
The US courts have ruled that Google is a monopoly, leaving it facing the prospect of a break-up. WIll that be a good thing?
By Matthew Lynn Published
-
How will the UK gambling sector be hit by the Budget?
There are concerns for the UK gambling sector in the lead-up to the Autumn Budget. What could be on the cards?
By Dr Matthew Partridge Published
-
HSBC returns to cost-cutting plan
HSBC is set to revamp its commercial banking division – but will it come at a cost?
By Dr Matthew Partridge Published
-
Is Brevan Howard Macro a good investment?
Holding Brevan Howard, a world-leading vehicle through an investment trust, offers diversification on the cheap
By Rupert Hargreaves Published
-
How can China boost consumption?
China's new policies may give consumption a cyclical boost, even if long-term gains require more serious reforms
By Cris Sholto Heaton Published
-
Pfizer shares rise as US investor takes $1 billion stake
Pfizer shares are on the up since US activist investor Starboard Value built up a stake in the drug maker. But strategic options appear limited
By Dr Matthew Partridge Published
-
What is the outlook for oil prices?
Oil prices will be set by the face-off between Saudi Arabia and US shale producers. Could tail risks change the possible outcome?
By Cris Sholto Heaton Published
-
A fairer deal for investment trusts
New rules on how investment trusts report costs should ditch the idea that investors only need to look at one number
By Cris Sholto Heaton Published