Spreads on investment-grade bonds continued to tighten during the fourth quarter and ended the year only 3 basis points (bps) above where they started the year. This is remarkable given the circumstances of the prior 12 months and the massive spread widening that occurred in March. While a second wave of coronavirus infections more powerful than the first hit countries around the globe in the fourth quarter, investor sentiment was buoyed by positive clinical news regarding vaccines. In addition, a continued commitment by the Federal Reserve to easy monetary conditions supported investors’ expectations that economic activity in 2021 will significantly exceed 2020 levels.
The Capital Group Long Duration Credit Composite posted a positive return for the fourth quarter. But given the relatively conservative positioning of the long credit portfolios, the composite trailed the strong returns of its benchmark, the Bloomberg Barclays U.S. Long Credit Index. Sector selection was responsible for most of the lag, and security selection also had a slight negative impact. Energy holdings were the largest positive contributor, while bank holdings were the largest detractor from results relative to the benchmark.
One technical factor that will likely be a tailwind in 2021 is that issuance is expected to be significantly lower. However, central bank policies have inflated financial asset prices, and at current spread levels investors are receiving little compensation for any potential risks. Thus, this is a time to be patient. While there is likely to be better economic news ahead, a remarkable amount of good news is already reflected in bond prices.
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