With the prospect of interest rate cuts on the horizon in the US, corporate bonds have started to perform well with the market already pricing in the cut expected in September, offering investors income and the opportunity for capital gain when the US Federal Reserve (the Fed) starts to lower interest rates, according to Darryl Bruce, executive director of capital markets at Income Asset Management.
“It looks like the US might be on the cusp of interest rate cuts in September, with an 85-to-90-per-cent chance of a rate cut priced in from the Fed that month,” Mr Bruce said. “Being at the top of the interest-rate cycle, it is likely that money going into the fixed income markets now will reward investors over the coming years as rates move lower.”
With yields on investment grade bonds hovering above 6 per cent, Mr Bruce added that investors are being lured into this asset class by relatively high returns.
“We are seeing strong demand for new bond issues. We've come from an environment a few years ago where yields were much lower and now, in the investment grade part of the market, we're seeing yields of 6 per cent-plus. That is driving a lot of investor interest. We recently saw that with a tier-two bond issue from Spanish bank giant Santander. We are also seeing plenty of issuance from the big four banks in Australia,” he said.
“Santander’s order book was over $4 billion. They only ended up issuing $600 million of bonds in Australia and we would have liked to have seen them issue a little bit more. The coupon came out very close to 6.5 per cent, which is probably 50 basis points higher than we're seeing on coupons for big Australian issuers, such as the banks.
“The Santander issue was only rated one notch weaker at Triple B-plus. This is good compensation for investors for the risk. It is also good to see a big global bank like Santander come into the Australian market to issue bonds,” he said.
According to Mr Bruce, with yields sitting relatively high on investment grade debt, it is a good time to be investing money into the corporate bond market.
“We're talking to clients and one consistent message we give is to look at where yields are now. Using the Santander issue as an example; if you can lock in a coupon of 6.5 per cent for the next five years from a from an institution of Santander's quality, that's 6.5 per cent return per annum for the next five years from a defensive asset in your portfolio. That’s a good outcome, and it is clear that money going into the bond market right now will reward investors over the coming years.
“That’s the story that we're talking about to investors.”
Mr Bruce also sees healthy outcomes for carefully selected private credit assets, which historically have offered an illiquidity premium over corporate bonds, which are publicly traded.
“In the higher yield loan environment, we see some great opportunities in the private credit market, and we'll continue to access that market,” he said. "Investors are picking up an extra 3 per cent or so return for going into some private credit assets compared to bonds, over a three-year period. Liquidity is a bit less of an issue for a three-year period so the payoff is attractive," Mr Bruce said.
