Asset manager Nuveen says bonds and loans issued by riskier U.S. companies with speculative or “junk” credit ratings likely offer investors better downside protection than stocks because investors price the risks of recession.
As investors focus on the Federal Reserve’s potential to rein in the US economy as it raises rates dramatically to help cool stubbornly high inflation, corporate bonds and loans offer far greater yields. that recent years likely offer investors better downside protection, Saira Malik, chief investment officer of Nuveen, wrote in a client note on Monday.
The ICE BofA US High Yield Index’s return more than doubled to around 8.4% from a record low of less than 4% around a year ago, even though ‘credit fundamentals look solid’ , according to Malik. The index tracks companies with a credit rating below investment grade or in the BB to D category.
While excessive borrowing may come back to bite, the record boom in pandemic debt issuance at ultra-low yields has been a positive for many companies with weaker credit profiles, she said, being given that “the debt burden is not excessive and that low financing rates have been locked in.”
Specifically, Nuveen estimated that around 75% of outstanding junk bonds and loans will mature after 2025 (see chart), giving speculative-grade companies more breathing room in the event of a recession, a threat that more investors, Wall Street analysts and corporate executives increasingly see it as likely.
Companies often end up defaulting when profits fall in a downturn, debt repayments climb too high, or they fail to repay or refinance maturing debt.
To that end, Nuveen notes that U.S. high-yield companies have generated earnings that cover about four times their annual interest charges, the highest level since 2008, and that default rates are unlikely to hit. current market expectations of around 5%.
Nuveen, a division of TIAA, has approximately $1.2 trillion in assets under management, with a particular focus on fixed income, equities and real estate.
The team performed a hypothetical stress test based on a 20% decline in equities and current bond and stock dividend yields, concluding that stock prices could fall 19.5%, but bonds at high yield only lost 4.5% and loans lost 4%.
The S&P 500 SPX index,
was down 19.7% on the year through Monday, while the Dow Jones Industrial Average DJIA,
was down about 14.6% and the Nasdaq COMP composite index,
was 27.5% lower for the same stretch, according to FactSet.
For bonds, total returns for the year to July 8 were negative 12.9% for US high yield, minus 14.3% for investment grade bonds and negative 4.6% for leveraged loans, according to Mizuho Securities.
Individual investors often gain exposure to high yield bonds through exchange-traded funds, including the large SPDR Bloomberg High Yield Bond ETF JNK,
and iShares iBoxx $ High Yield Corporate Bond ETF HYG,
which were down about 15% and 13.8%, respectively, so far in 2022, according to FactSet.
While over the long term, Nuveen expects equities to “offer a higher upside”, equities appear more vulnerable to “near-term risks, particularly in the uncertainty of the ongoing earnings season”. .