The Capital Group Inc Singapore — Seeking Returns in Any Market Environment

Why should investors consider investment-grade corporate bonds in the current environment?

Investment-grade (BBB/Baa and above) corporate bonds can be an excellent asset class for long-term investors.

The primary investments are bonds issued by large, well-known US companies. Beyond the diversification benefits, these bonds typically earn a return above Treasuries over a long period of time.

Moreover, they have done so with lower volatility compared with riskier assets such as equities or high-yield bonds and can help provide capital preservation.

We believe that the US investment-grade market looks particularly attractive given the higher yield compared to low domestic yields in most Asian markets.

Additionally, the broader opportunity set and the deeper liquidity of the US credit markets provide both strategic and tactical investment advantages.

There is also the added benefit of a lower correlation with global equity markets.

If global investors have the capability to buy unhanged risk, even if US interest rates rise modestly, they could benefit from a stronger dollar.

Even in hedged cases, global investors can pick up 80–150 basis points depending on the structure, credit quality and maturity of the bond.

How do you currently see valuations within the asset class?

Fundamental valuations are fair. Although spreads seem somewhat attractive compared with historical levels, if we look at the leverage in the broad corporate bond market, it is at or has exceeded the peak levels of 2007.

However, while leverage is high, the cost of debt service is muted and manageable because of the low absolute level of yields.

Interest rates are so low that the average coupon paid is half of what it was 10 years ago.

Thus, almost all higher quality companies are in a much better position to service their debt.

It is also important to note that US banks are in much better shape than they were in 2008 as they have now increased their Tier 1 capital, and balance-sheet strength is strong and proprietary risk-taking reduced.

Although expectations are for US interest rates to rise, we expect this to happen at a very gradual pace and it will take years for debt service cost to seeking returns in any market environment.

Luke Farrell, fixed-income investment director and leader of the fixed-income investment specialist team globally, shares his views on valuations within US investment-grade credit.

By way of example, if a company’s bonds have an average maturity of eight years and they do not have to refinance for the next eight years then their debt service costs should remain constant even as rates rise.

Furthermore, if rates are rising, you would expect that to be associated with a stronger economy and increasing earnings and profits, which in turn would better enable companies to service their debt.