While Treasury bonds receive the most attention and municipal bonds offer tax efficiency, corporate debt is often referred to as the last safe investment. In Part Four of our fixed income series, we’ll discuss the risks and benefits of investing in corporate debt, and the best ways to gain exposure.
In the balance of risk versus reward, bonds that pay more are expected to carry a higher likelihood of default. However, in recent years corporate bonds have called that balance into question. With recession fears looming over equity markets, corporate bonds may be a critical avenue for financial advisors to find their clients new yield opportunities within their risk profile.
No investment-grade corporate bond has defaulted since 2016, according to data from S&P Global Ratings, despite offering higher returns than Treasuries and municipal bonds. As a result, corporate debt has gained in popularity among investors and their advisors.
Douglas Boneparth, president of RIA Bone Fide Wealth, says corporate debt is a classic volatility dampener.
“We’re looking here at an asset class less correlated to the equity market,” he says. “If you’re looking at a drawdown or a recession, you’re getting hit. But if you are holding high-quality corporate debt, you are not taking the hit you’re taking on your equity positions.”
Investors have been piling into corporate debt funds as fears of a global recession are spurred by stalling global economic growth, the U.S./China trade war, growing alarm over a potential conflict in the Middle East and a messy divorce between the European Union and the United Kingdom. Investors have socked away $122.87 billion into investment-grade corporate bonds funds this year as of September 18, according to data provided by Lipper from Refinitiv.Not only are investors buying, but corporations are rushing to issue debt as interest rates continue to hover around record lows. Bloomberg reported that a record 21 companies sold $27 billion in investment grade bonds on Tuesday, September 3. Sales the next day brought the totals to 35 companies selling $54 billion in investment-grade debt in just two days.
“If I were a CFO of a large Fortune 500 company, now is the time to issue corporate debt,” says Payson Swaffield, chief income investment officer at Eaton Vance. “Credit spreads are near record lows and interest rates are low, so if investors want to buy your debt — fantastic.”
Swaffield says corporate investment grade debt has been a great place to hide out during periods of uncertainty, but he cautions that now might not be the best time to invest in corporate debt if you haven’t already. He says investors who didn’t move into corporates by the beginning of the year missed out on great performance. The S&P 500 Investment Grade Corporate Bond Index has returned 10.8% year-to-date, versus 6.05% for the S&P National AMT-Free Municipal Bond Index and 8.34% for the S&P U.S Treasury Bond 7-10 Year Index.
“As of the end of August, the yield was about 2.8%, a spread of about 120 basis points over Treasuries,” Swaffield says. “That is low by historical average.”
Boneparth notes that investment grade corporate debt is always an important component of a balanced portfolio and serves as a way to be “risk-off” without being in cash.
Swaffield says mutual funds are the best way to gain exposure to investment-grade corporate debt. “It has been a great place to be with declining interest rate environment, and in this period of uncertainty, corporate investment grade has been a great place to hide out.”
Ultimately, Boneparth says investors must figure out how assets such as corporate debt fit their objectives. “Let your goals dictate your risk tolerance and let your risk tolerance dictate your asset allocation.”