Much media and investors attention focusses upon equity markets particularly when they slump as happened when the COVID 19 pandemic went global. The fall in the FTSE 100 became front page news, or whatever the on-line equivalent is these days!
Much less is written about Fixed Income markets despite them dwarfing the equity markets in value and number of holdings. And yet they form an intrinsic part of diversified portfolios and pensions. Indeed, they often give a strong indication of where equity markets will go.
To re-cap, Fixed Income is about debt. Governments and companies alike borrow money, normally with a fixed annual interest payment (the coupon) and repayment date. Investors are the lenders of that capital, earning interest on their investment and expecting repayment of the capital on the due date.
Whilst there are many other complexities to consider, broadly, government debt in the UK is deemed safe in that the government will not ‘go bust’ and therefore the debt will be re-payed to the lender (investor). And yes, that normally involves issuing more debt and, in extremis, printing money.
Companies can go bust and the lender potentially loses both capital and income. So how have corporate bonds fared this in the market crash?
Initially, at the beginning of March, we saw the textbook response. As panic in equity markets set in Gilts rose as investors sought safe havens and liquidity. Never mind that by almost any measure, government debt was already overpriced so they were locking in vanishing small returns.
Corporate Bonds fell in value. This makes sense if the risk of more companies failing has increased as it certainly did. So, the gap (in market language, the spread) between gilts and corporate bonds widened, dramatically so, in March. Many of the Fund Managers we speak to and invest with saw this as a great opportunity.
Different companies have different credit risk, and this is reflected in debt markets. Riskier companies, maybe by dint of their size, other debts, or type of business will have to pay higher interest (the coupon) to borrow money than more secure companies. They have a lower credit rating.
Two things combined in favour of Corporate Bond managers. The eye-watering Central Bank money printing in the US was aimed directly at corporate bonds to avoid bankruptcies. This put a floor under the market for investors after the drop. Then solid, secure companies chose to borrow, albeit paying higher interest, to shore up balance sheets to survive the pandemic and possible second wave.
One Bond Fund manager with whom we invest as a core holding in portfolios described this as a sweet spot. They were able to sell very expensive gilts, to invest in ‘blue chip’ company debt at a much higher rate of interest. They have seen a recovery in value as Bond markets have settled, and unlike so many equity investments are confident that their income payments will increase this year.
We have been adding to Fixed Income for clients during the volatility as it became clearer that interest rates would remain negligible for a long time yet and value had re-emerged in the downturn.
As with the pandemic, in markets we may be past the very worst, but are vigilant and wary of setbacks. Amongst corporate bonds, it has been pleasing to have a silver lining for client portfolios.