Attractive opportunities in corporate bonds
Munsbach, 17th July 2020 – Corporate bonds continue to be the primary focus of the bond portfolios within the Ethna-AKTIV and the Ethna-DEFENSIV. This asset class has already made a positive contribution to the performance of both funds over the course of the year and we anticipate that this will continue. Nevertheless, our expectations were severely tested during the coronavirus crisis. Not only did the prices of so-called risk assets, such as equities, crash but from mid-March onwards, the prices of corporate bonds also plummeted sharply for a short time. Even the prices of high-quality corporate bonds lost more than 10 percent within the space of two to three weeks and were temporarily impossible to sell.
Thanks to the rapid and decisive intervention of the central banks, this price decline was initially mitigated and has now been almost reversed. High-quality corporate bonds are now trading just below their highs for the year and liquidity is also approaching pre-crisis levels. USD-denominated corporate bonds with short to medium residual maturities have performed particularly well, as their prices have not only benefited from the massive interest rate cuts but also directly from the US Federal Reserve bond purchase programmes. Yet how exactly did the central banks manage to stabilise the bond markets?
On Sunday March 15, the US Federal Reserve lowered the target range for the Fed Funds Rate by 100 basis points to between 0 and 0.25 %. In addition, it also began its large-scale purchase of US Treasuries. Since then, these purchases have reached more than USD 1.6 trillion. On March 23, barely a week after the rate cut, the Fed approved a USD 750 billion corporate bond purchase programme. The first purchases, which did not take place until May, only concerned investments in ETFs and therefore were only indirectly related to corporate bonds. Recently, the Fed published a specially defined index that includes those corporate bonds that it intends to buy directly in the future. However, the remaining duration of these bonds should not exceed five years. The ECB, on the other hand, can virtually no longer lower its short-term interest rates and must therefore focus on further purchase programmes. On March 18, it decided to purchase bonds to the tune of EUR 750 billion until the end of 2020 under the newly created Pandemic Emergency Purchase Programme, or PEPP. Approximately 80% of these purchases relate to sovereign bonds and around 10% each to corporate bonds and covered bonds. On June 4, the ECB also decided to expand the PEPP by EUR 600 billion and to extend it until at least June 2021.
This leaves no doubt that the central banks will buy corporate bonds for the foreseeable future. A significant number of large companies have used the past three months to improve their liquidity and convert short-term debt into long-term debt. Even if the coronavirus crisis were to worsen once more, it is safe to assume that these companies will not require additional liquidity and would therefore not increase their issuing activity again. In these cases, steady demand will be met with a renewed decline in supply, which will lead to price gains for those corporate bonds with low volatility. Therefore, we do not expect liquidity problems to return. Unlike at the beginning of the year, and following the widening of risk premiums, there are again attractive opportunities for companies without an investment-grade rating, whose bonds have not benefited directly from central bank purchases. This is why in recent weeks we have also selectively included bonds from this sector in the Ethna-AKTIV and the Ethna-DEFENSIV portfolios.
Now that the central banks have reassured the bond markets with their monetary policy measures, we expect that the various fiscal measures will support the global economy and should strengthen the profitability of many companies. Thanks to the aforementioned measures to improve the liquidity of both corporations and the bond market, short-term insolvency is no longer a risk for the majority of companies. However, only after the end of the purchasing and fiscal programmes will it become clear which business models are viable in the future, even if customer behaviour changes. Then the selection and consequently the focus on sustainably attractive business models will again play a greater role in successful long-term portfolio construction.
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ETHENEA Independent Investors S.A.
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