Considerations for corporate bonds and your portfolio


By Brian Erickson, Vice President - Fixed Income, Ameriprise Financial

Key Points

  • Be on the right side of the divide in corporate bonds.
  • Strong companies are poised to thrive while defaults among high-yield bonds jumped in the second quarter.
  • Your Ameriprise advisor is committed to regularly reviewing your long-term investment portfolio with you, including fixed income allocations.

The pandemic has altered the corporate-debt landscape, creating opportunities and pitfalls for bond investors. As a result, now is a good time to revisit your investment portfolio with your Ameriprise advisor.

 

The path of bond markets to date

In March, Congress and the Federal Reserve announced their intention to help support and stabilize corporate debt markets by buying corporate bonds. Corporate bonds are debt instruments that large firms sell to investors to raise capital for daily operations, for example. And even the suggestion of government support renewed investors’ willingness to buy bonds. As a result, investors quickly returned to credit markets — and well before the support effort took effect.

Subsequently, high-quality investment-grade companies raised nearly $1.2 trillion of new funding through the end of the second quarter, which was near twice last year’s pace.1 With greater liquidity, these companies — which already hold leading market share in their industries — appear poised to thrive following the pandemic crisis.

Conversely, defaults among riskier, high-yield companies jumped in the second quarter.2 These riskier companies operate with more debt, less financial flexibility and less differentiated market positions. As a result, they may not be able to access new funding and may fail during continued economic disruptions.

 

Fallen angels and defaulters

In 2019 and early this year, the low cost of funding generally encouraged companies to operate with more debt. As a result, corporate bond markets were concentrated in one of two categories:

  • BBB-rated companies, considered lower investment-grade quality
  • Single-B-rated companies of a more leveraged, speculative-grade quality

Dramatic changes in consumer and business needs created headwinds across many sectors during the pandemic. That led to rating cuts in March and April for a number of BBB-rated investment-grade companies in the leisure and energy industries, in particular. Often through no fault of their own, these “fallen angels” slipped into the high-yield, non-investment-grade category, with more limited financial flexibility. Weak second-quarter earnings could result in another round of fallen angels as new downgrades occur.

On the lower end of the rating spectrum, riskier single-B-rated companies also have been downgraded. Some hang on the edge of bankruptcy or have defaulted. Others have taken on more debt to navigate the economic disruptions. While providing a breath of life, the additional debt in an already highly leveraged company may ultimately be the last straw when the temporary boost of cash runs out. We believe restructurings or defaults likely will continue into 2021 and result in a permanent loss of principal for investors.

 

Active management benefits

Bond prices have rallied since March, as markets priced in the benefits of Fed support and the CARES Act. Because non-investment-grade bonds no longer yield materially more than investment-grade bonds, we recommend investors consider overweighting portfolios with high-quality companies.

We also prefer an active (versus passive) approach to corporate bond investing, in which portfolio managers carefully select from winners and losers. An active investment approach may more effectively identify companies that can successfully navigate the current operating environment.

Alternatively, we believe investments linked to broad fixed income indices (e.g., exchange-traded bond funds) likely face a higher possibility of losses from defaults. They also may unknowingly absorb the losses given they are not actively managed. Already, defaults are rising in retail and consumer segments as companies run out of cash.

 
Be selective and focus on quality

Today, there are more differences between industries and companies than we have seen over the past decade. For example, there is more disparity in the strength of balance sheets and competitive advantages. These differences are due to pandemic-driven changes in business and consumer demands and the impact of disruptive technologies.

The current environment favors companies that are positioned to exploit the shift in demand and who maintain strong balance sheets. In our view, investors should rely on support from an Ameriprise advisor, stick with high-quality companies and use a selective, active approach to corporate bond investing.

 

1 Bloomberg as of 7/1/2020

2 Moody’s Investors Service as of 7/13/2020