2024 looks set to offer investors a good entry point to the asset class.
Both 2022 and 2023 were dominated by high inflation and interest rate hikes, which led to a sharp repricing of more duration sensitive parts of the market – government bonds and investment grade corporates. While high yield corporate bond markets performed much better, we are now more cautious of the impact of elevated refinancing costs and a deteriorating economic backdrop on more highly leveraged corporate issuers.
At the same time, investors have once again been able to find attractive cash savings rates. Why do we believe bond markets, and in particular better quality corporate issuers offer an attractive opportunity? What is there to tempt investors out of cash?
The final months of 2023 saw a strong rally in the bond market off the back of rising optimism for swift and significant rate cuts. But 2024 started with central banks pushing back against market expectations. Markets have given back some of their gains. Yields for investment grade bond markets are attractive versus the levels we’ve seen for the past decade.
Chart 1 – Investment grade index yield to maturity. Source Macrobond, ICE BofA indices, to 31/1/24.
The new issue market has given us many opportunities across a range of different types of bonds. These include investment grade, corporate hybrids and subordinated financials. One area where we have been extremely selective is high yield.
Why we like investment grade
In investment grade, although credit spreads are tight, reflecting healthy fundamentals, attractive yields and relatively low net new issuance is already driving flows into the asset class. We’ve also seen a good amount of new issuance that we believe to be well priced, across the board.
Examples we’ve added to our more investment grade focused funds include:
London Power Networks - issued a GBP 5.875% coupon, A- rated bond that matures in 2040
Suez - EUR 4.5%, BBB rated, maturing 2033
JP Morgan - EUR 4.457%, A rated, senior bond maturing in 2031
Some high yield caution
In high yield, there has been very limited new issuance over the past couple of years after corporates issued extensively in 2020 and 2021. As a result, the ‘maturity wall’ is getting ever closer and corporates will have to fund at much higher rates than they’ve previously been able to.
This, coupled with deteriorating economic data, including rising insolvencies and delinquencies, is making us more cautious on high yield.
In those funds with a bias towards higher yielding parts of the market we’ve been improving the overall credit quality. This reflects our view of the challenges that many high yield borrowers will face in an environment of higher borrowing costs, but also serves to protect against the risk of an economic slowdown.
Whilst it’s uncertain whether an economic slowdown will happen, we have far more certainty around the risks that higher borrowing costs pose to the high yield bond market. We’re very wary of those borrowers with higher leverage, whose balance sheets were put together in a very different borrowing environment. Even factoring in further declines in interest rates and yields, these companies may not be able to refinance at an affordable level.
It’s notable that there’s been a clear dispersion between the yield demanded for stronger and weaker credits. While the spread on European BB and B-rated bonds fell, those on bonds rated CCC and below rose substantially.
Chart 2 – European Currency High Yield index spread. Source Macrobond, ICE BofA indices, to 31/1/24.
This scenario, while challenging, should offer good alpha generating opportunities and will ultimately reward active portfolio management and a rigorous credit selection process. Although aggregate spread levels are not generous, we do still expect European high yield to deliver positive total returns in 2024 thanks to carry from the higher starting yield in the market.
Alternatives to high yield
While we’ve reduced exposure to high yield companies, we’ve been happy to take some more exposure to subordinated debt in stronger companies. We’ve increased investment in corporate hybrid bonds. These are junior bonds but the issuing companies are typically large, investment grade rated names.
We’ve also added to subordinated financials, including AT1 bank debt. Following the sell-off last March, both banks and regulators have taken steps to ensure the continuing health of the AT1 market and it has performed well.
Example of recent issues include:
Societe Generale - USD 10%, BB rated AT1, callable in 2028
Barclays - USD 9.625%, BB rated AT1, callable 2029
AXA - EUR 6.375%, BBB+ rated, callable 2033
In funds with a focus on delivering a high income, we can take a little more credit risk at the issuer level, and find examples such as:
Co-Operative Bank – GBP 11.75%, BB rated. Subordinated bond maturing 2034
Virgin Money – GBP 11%, BB rated AT1 callable 2029
To answer our earlier question, of what’s out there to tempt investors out of cash - interest rate cuts are expected from the US Federal Reserve, European Central Bank and Bank of England in the first half of this year. Falling interest rates will feed through quickly to the rates achievable on savings accounts.
In bond markets though, we continue to have the opportunity to ‘lock in’ attractive income streams that can benefit the funds for many years, without taking on too much in the way of credit risk. We have already started to see early signs that investors are reallocating from cash to bond markets, especially investment grade.
At Invesco, we offer a broad range of fixed income capabilities. Whether you’re looking for income, diversification, capital preservation or total returns, our global fixed income teams have the strategies, the scale and the flexibility needed to match your objectives. Access this expertise through our active, passive, mainstream, innovative and ESG solutions.
Explore some of our investment grade credit capabilities:
- Invesco Corporate Bond Fund
- Invesco Global Investment Grade Corporate Bond Fund
- ESG Corporate Bond ETFs
Investment risks
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.
Invesco Corporate Bond Fund (UK) is theme-based or invests in a specific sector or a small number of sectors and/or industries. Investors should be prepared to accept a higher degree of risk than for a Fund that is more widely diversified across different sectors/industries.
The debt securities that the fund invests in may not always make interest and other payments and nor is the solvency of the issuers guaranteed. Market conditions, such as a decrease in market liquidity, may mean that the Fund may not be able to buy or sell debt securities at their true value.
The Fund has the ability to make use of financial derivatives (complex instruments) which may result in the Fund being leveraged and can result in large fluctuations in the value of the Fund. Leverage on certain types of transactions including derivatives may impair the Fund’s liquidity, cause it to liquidate positions at unfavourable times or otherwise cause the Fund not to achieve its intended objective. Leverage occurs when the economic exposure created by the use of derivatives is greater than the amount invested resulting in the Fund being exposed to a greater loss than the initial investment.
The Fund may invest in contingent convertible bonds which may result in significant risk of capital loss based on certain trigger events.
The Fund’s performance may be adversely affected by variations in interest rates.
Invesco Global Investment Grade Corporate Bond Fund risks
Debt instruments are exposed to credit risk which is the ability of the borrower to repay the interest and capital on the redemption date.
Changes in interest rates will result in fluctuations in the value of the fund.
The fund uses derivatives (complex instruments) for investment purposes, which may result in the fund being significantly leveraged and may result in large fluctuations in the value of the fund.
The fund may invest in certain securities listed in China which can involve significant regulatory constraints that may affect the liquidity and/or the investment performance of the fund.
As this fund is invested in a particular sector, you should be prepared to accept greater fluctuations in the value of the fund than for a fund with a broader investment mandate.
The fund may invest in contingent convertible bonds which may result in significant risk of capital loss based on certain trigger events.
Important information
Data as at 31.01.2024, unless otherwise stated.
Views and opinions are based on current market conditions and are subject to change.
For information on our SICAV funds and the relevant risks, refer to the Key Information Documents/Key Investor Information Documents (local languages) and Prospectus (English, French, German, Spanish, Italian), and the financial reports, available from www.invesco.eu. A summary of investor rights is available in English from www.invescomanagementcompany.lu. The management company may terminate marketing arrangements. Not all share classes of this fund may be available for public sale in all jurisdictions and not all share classes are the same nor do they necessarily suit every investor. For the most up to date information on our ICVC funds, please refer to the relevant fund and share class-specific Key Investor Information Documents, the Supplementary Information Document, the financial reports and the Prospectus, which are available using the contact details shown.
This is marketing material and not financial advice. It is not intended as a recommendation to buy or sell any particular asset class, security or strategy. Regulatory requirements that require impartiality of investment/investment strategy recommendations are therefore not applicable nor are any prohibitions to trade before publication.
Issued by Invesco Fund Managers Limited, Perpetual Park, Perpetual Park Drive, Henley-on-Thames, Oxfordshire RG9 1HH, UK. Authorised and regulated by the Financial Conduct Authority and Invesco Management S.A., President Building, 37A Avenue JF Kennedy, L-1855 Luxembourg, regulated by the Commission de Surveillance du Secteur Financier, Luxembourg.
