(Bloomberg) — Corporate bond valuations are in nosebleed territory, signaling the biggest warning in nearly three decades, as an influx of money from pension fund managers and insurers increases competition for assets. So far, investors are optimistic about the risk.
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Many money managers don’t see valuations coming back down to earth anytime soon. Spreads, the premium for buying corporate bonds over safer government bonds, could remain low for an extended period, partly because budget deficits have made some government bonds less attractive.
“It could easily be said that spreads are too tight and you should go elsewhere, but that’s only part of the story,” said Christian Hantel, portfolio manager at Vontobel. “If you look at history, there have been a number of periods where spreads have remained tight for quite some time. We are currently in such a regime.”
For some money managers, the high valuations are cause for concern, and there are now risks involved, including inflation weighing on corporate profits. But the investors buying the securities are attracted to yields that seem high by the standards of the past two decades and are less focused on how they compare to government bonds. Some even see room for further compression.
Spreads on U.S. high-grade corporate bonds could shrink to 55 basis points, Invesco senior portfolio manager Matt Brill said at a Bloomberg Intelligence credit outlook conference in December. On Friday they were indicated at 80 basis points or 0.80 percentage points. Europe and Asia are also approaching their lowest levels in decades.
Hantel cited factors such as shorter index duration and improving quality, the tendency for the price of discounted bonds to rise as they get closer to redemption and a more diversified market as trends that will keep spreads tight.
Take BB-rated bonds, which have more in common with the debt of large corporations than highly speculative bonds. They are close to their highest ever share of global junk indices. Moreover, the percentage of BBB bonds in high-quality trackers – a major source of anxiety in recent years due to the increased risk of downgrades to junk – has been falling for more than two years.
Investors are also focusing on carry, an industry parlance for the money bondholders make from coupon payments, after any leverage costs.