Where to go for risk?
We all know people have different approaches to risk. Some of us like to take physical risks in search of an adrenaline high, while others take investment risks chasing hot stocks. The majority of the population, we suspect, stick to the sofa, and there’s nothing inherently wrong with that.
In today’s market though, you could go so far as to say that investors have no safe ‘sofa’ option; if you want a return, you need to take some risk. But you can still choose which risks you want to take. Our piece this month is about where we think the risk/reward balance is most compelling in fixed income at the moment.
When it comes to taking risk, there are two areas to consider. The first is the most obvious – what you invest in and its associated risks. The second comes through the degree of protection you can build into your portfolio, whether that comes through traditional safe haven assets such as government bonds or something else.
Of high yield and hybrids
US high yield bonds are one of our favoured areas in fixed income today. There is greater diversification to be found in US high yield over its lower leveraged European equivalent, particularly in the CCC-rated space. We think there is value in market at the shorter end of the maturity spectrum, especially when you compare US high yield to high quality investment grade.
As a general rule of thumb, we saw a yield floor of around 5% in US high yield in the pre-COVID cycle. Following on from the monetary response to COVID-19, we think that yield floor has dropped and indeed it did go through the 4% level recently.
In the investment grade space, corporate hybrid bonds are potentially an interesting opportunity. These are generally higher yielding than conventional bonds because the issuer has more optionality around the call date of the bond and the payment of the coupon. As well as the higher yield, we also think there is the potential for some spread tightening as hybrid bonds catch-up with the recent tightening seen across fixed income markets more broadly.
Hybrids in the telecommunications and utilities sectors tend to issue the most hybrid debt as they stable revenues, which helps to give investors confidence that they should lend to these good quality companies issuing bonds in a more subordinated structure. Here, as always, fundamental credit analysis is critical.
The subject du jour
There is lots to talk about when it comes to fixed income at present. There is plenty to watch in the next few months, and we dare say we will be writing about our view on government bonds in the near future, particularly with the upcoming Federal Reserve meeting in March. High yield and hybrids are our favoured areas within higher risk fixed income for now as we look to generate returns for 2021.