Capital Ideas^TM

Why investment grade corporate bonds?

We believe bonds can serve four central roles in a balanced portfolio, namely:

These roles can aid in pursuing retirement goals or help stabilise a portfolio to be more resilient when economic shocks hit markets. Due to the characteristics of investment grade corporate bonds, they could be an ideal asset class to fulfil most of these roles simultaneously in a balanced portfolio. As such, they could readily serve as the core fixed income element of a portfolio. Global investment-grade corporate bonds have provided an attractive alternative to developed market sovereign bonds, potentially offering both higher income and higher returns as well as diversification from equities and capital preservation.

Income

Fixed income fundamentally differs from equity in its explicit income component. Although some common and preferred stocks pay dividends, these income streams can fluctuate or disappear at a company’s discretion. Bonds typically carry more explicit and predictable income streams in the form of coupons, so long as the issuer remains solvent. Investment grade corporate bonds therefore have the potential to provide a reliable stream of income for investors with income return having served as a large component of total returns. This could help provide a cushion to total return should price movements remain volatile.

Capital preservation

The market’s focus is shifting towards the prospect of slower growth and the rising risk of recession. However, corporate fundamentals remain in good shape, which should help investment grade companies to navigate a slow-growth environment. Default risk for investment grade corporates is relatively low compared to high yield bonds, and even if the global economy enters a recession, this would likely lead to an increase in downgrades and fallen angels ¹ rather than defaults. It should be noted though that this would also likely result in an uptick in volatility and a widening in spreads.

In addition, investment grade corporate bonds can limit the downside in periods of market volatility, particularly in the contraction phase of the business cycle. As duration of the asset class has extended, interest rates have become a larger component of total returns. Should a mild recession transpire, and interest rates begin to fall, investment grade bonds could offer a degree of resilience through their longer duration profile. As illustrated by the graph below investment grade bonds have outperformed riskier asset classes such as equities and high yield corporate bonds during periods of business cycle contractions since 2001, which is when our available data set began.

Similarly in periods of large equity drawdowns since 2001 investment grade corporate bonds have fared better than other risky assets such as equities and high yield bonds as shown by the following graph.

1. Fallen angel: a bond downgraded from investment grade to high yield status.

 

Risk factors you should consider before investing:

• This material is not intended to provide investment advice or be considered a personal recommendation.
• The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment.
• Past results are not a guide to future results.
• If the currency in which you invest strengthens against the currency in which the underlying investments of the fund are made, the value of your investment will decrease. Currency hedging seeks to limit this, but there is no guarantee that hedging will be totally successful.
• Risks may be associated with investing in fixed income, emerging markets and/or high-yield securities; emerging markets are volatile and may suffer from liquidity problems.