A Changed Landscape for U.S. Investment-Grade Corporate Bonds
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April 2021
Fixed-Income Insights
A Changed Landscape for
U.S. Investment-Grade Corporate Bonds
Spreads on US investment-grade corporates have returned to pre-pandemic levels.
How might investors approach the asset class in the current environment?
by Ritchie Oriol, Investment Strategist
n In 2021, investment-grade corporate bonds endured their worst opening quarter in 30 years, as the impact of
rising interest rates on the value of corporate bonds significantly outweighed any income and spread tighten-
ing that occurred over the quarter.
n Normally, such an outcome would lead investors to review their allocation to the asset class. Indeed, with the
normalization of the United States underway and with it, commensurate expectations for strong economic
growth, concerns over the impact of inflation remain a risk.
n Despite this, the attraction of rotating into cash remains limited as risk-free yields provided by US T-bills
remain at historic lows.
n In this environment, we believe investors should embrace a flexible approach to high-quality fixed income and
consider strategies that mitigate the impact of higher interest rates, which could rise further as the U.S.
economy enters a period of robust, above-trend growth.
Following the extremely strong returns investors in investment- robust rollout of vaccinations in the United States led to a
grade (IG) corporate bonds enjoyed over the last three quarters significant sell-off in longer dated US Treasuries, causing
of 2020, the first quarter of 2021 provided a cause for pause. duration-sensitive US IG corporate bonds to endure their worst
The historic interventions undertaken last year by the US Federal start to the year in three decades. Indeed, US investment-grade
Reserve (“Fed”) to underpin the orderly functioning of the corporates (as represented by the ICE BofA US Corporate Bond
financial markets in response to COVID-19, including rapid and Index) returned -4.5% in Q1 – the positive impact of modest
meaningful rate cuts and the unprecedented purchase pro- spread tightening over the quarter and income were over-
grammes for investment grade (and to a limited extend below whelmed by negative price returns due to the impact of rising
investment grade) corporate securities stabilized sentiment. As rates on duration.
a result, spreads of investment-grade corporate bonds reverted With this backdrop, how should investors in high grade debt
from levels often associated with high yield in March 2020 to with a focus on income evaluate the opportunity set? We believe
those found pre-crisis levels by early January 2021 (Figure 1, income-oriented investors in the asset class are likely to stay the
second page). course in the near term. Broad macroeconomic conditions
In recent months, landmark fiscal stimulus via the US$1.9 trillion remain favourable - overall consumer confidence continues
COVID Relief package, encouraging economic indicators and a to improve1 as has the economic outlook from the perspec-
1Figure 1. Spreads on Investment-Grade US Corporate Bonds Have Returned to Pre-Crisis Levels
Option adjusted spread on the ICE BofA Corporate Index, 1 January 2019–31 March 2021
450
400
350
300
Spread (bps)
250
200
150
100
50
0
12/31/18
01/31/19
02/28/19
03/31/19
04/30/19
05/31/19
06/30/19
07/31/19
08/31/19
09/30/19
10/31/19
11/30/19
12/31/19
01/31/20
02/29/20
03/31/20
04/30/20
05/31/20
06/30/20
07/31/20
08/31/20
09/30/20
10/31/20
11/30/20
12/31/20
01/31/21
02/28/21
03/31/21
Source: Bloomberg. Data as of 31 Mar 2021. The option-adjusted spread (OAS) is the measurement of the spread of a fixed-income security rate and the risk-free rate of return,
which is adjusted to take into account an embedded option. Past performance is not a reliable indicator or guarantee of future results. For illustrative purposes only and does
not represent any specific portfolio managed by Lord Abbett or any particular investment. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not
available for direct investment.
forecasts for US GDP for 2021 are expected to normalize above shorter maturities, 1-3 year US corporates provide yields over
trend levels in the second half of this year (Figure 2, third page). 10x the level of those same T-bills. And although income
Perhaps more important is that unlike in previous periods, the should not be the sole determinant for asset allocation, in an
alternatives for safe income are meagre (Figure 3, fourth page). environment where spreads are tight and expected to remain
While US investment-grade corporates provided yields of just rangebound, carry should be considered an important compo-
over 2.25% as at the end of March 2021, that is 40x the yield nent of return.
provided by 12-month US T-Bills. For those investors targeting
2Figure 2. For 2021, a Vaccine-Led Normalization of US Economic Activity Is Expected
15
10.2
10
YoY GDP Change (%)
5
3.7 3.5 3.6 3.4
2.3
0.3
0
-0.7
-2.4
-2.9
-5
-10 -9.0
4Q19 1Q20 2Q20 3Q20 4Q20 1Q21 2Q21 3Q21 4Q21 1Q22 2Q22
Sources: Trading Economics, BEA (U.S. Bureau of Economic Analysis), and Credit Suisse U.S. Equity Strategy Navigator, 1/4/2021. YoY = year-over-year. The historical data
shown in the chart above is for illustrative purposes only and do not represent any specific portfolio managed by Lord Abbett or any particular investment.
3Figure 3. Yields on US Corporate Bonds Far Outstrip Those of 12-Month T-Bills
Yields and yield ratios for the indicated asset classes, 1 January 2014–31 March 2021
IG v 12M UST (LHS) 1-3Y IG v 12M UST (LHS) 12M UST Yield (RHS)
40 4.0
3.5
30 3.0
2.5
Yield Ratio (%)
Yield (%)
20 2.0
1.5
10 1.0
0.5
0 0.0
Dec-13
Jun-14
Dec-14
Jun-15
Dec-15
Jun-16
Dec-16
Jun-17
Dec-17
Jun-18
Dec-18
Jun-19
Dec-19
Jun-20
Dec-20
Source: Bloomberg. Data as of 31 Mar 2021. IG=Investment grade US corporate bonds. 1-3Y IG= 1-3 Year Investment grade US corporate bonds. UST=US Treasury bills.
LHS=left-hand side. RHS=right-hand side. Past performance is not a reliable indicator or guarantee of future results. For illustrative purposes only and does not represent
any specific portfolio managed by Lord Abbett or any particular investment. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for
direct investment.
Further, if you consider the default risk associated with investment Even more effective, in our view, would be a multi-sector approach
grade corporates, we believe investors are more than well com- to access opportunities in adjacent fixed income asset classes to
pensated for the risk as spreads remain significantly wider than provide a wider opportunity to identify attractive relative value as
what would be justified by default risk. Along these lines, Bank of well as to complement the overall return profile and enhance the
America recently highlighted that the average historical loss for risk/reward characteristics of IG corporate fixed income alloca-
investment grade bonds due to defaults were about 12 basis tions. And because the excess return available in high quality
points per annum over the 30-year period ending 2019.3 short term credit is largely compensation for liquidity risk rather
than principal risk due to default, a multi-sector approach with a
As markets have moved from crisis management mode in 2020 to
focus on true short duration assets can potentially provide
normalization today, how might investors mitigate downside risk
enhanced yields without sacrificing overall portfolio credit quality
and take advantage of an evolving landscape in corporate credit?
or liquidity.
For those focused on the broad investment grade asset class
itself, we suggest an active approach with emphasis on identifying
relative value across credit rating and industry. We think this calls
for a sensible approach to duration in an environment that is likely
to continue to experience upward pressure on inflation and yields 4
on longer-dated government bonds.1
Source: Bloomberg; as measured by the University of Michigan Consumer Duration is a measure of the sensitivity of the price (the value of principal) of
Sentiment Index as at 31 March 2021. a fixed-income investment to a change in interest rates.
2
Source: Bloomberg, as measured by the US Business Roundtable CEO Securitized products (also known as structured products) are pools of
Survey Economic Outlook Index, as at 31 March 2021. financial assets that are brought together to create a new security, which is
3
BofA Global Research, Situation Room, 25 March 2021. then divided and sold to investors.
A Note about Risk: The value of investments in fixed-income securities will Spread is the percentage difference in current yields of various classes of
change as interest rates fluctuate and in response to market movements. fixed-income securities versus Treasury bonds or another benchmark-bond
Generally, when interest rates rise, the prices of debt securities fall, and measure. A bond spread is often expressed as a difference in percentage
when interest rates fall, prices generally rise. High-yield securities, some- points or basis points (which equal one-one hundredth of a percentage
times called junk bonds, carry increased risks of price volatility, illiquidity, point).
and the possibility of default in the timely payment of interest and principal. The ICE BofA U.S. Corporate Index tracks the performance of U.S. dollar
Bonds may also be subject to other types of risk, such as call, credit, denominated investment grade corporate debt publicly issued in the U.S.
liquidity, interest-rate, and general market risks. Longer-term debt securities domestic market. The ICE BofA 1-3 Year U.S. Corporate Index is a
are usually more sensitive to interest-rate changes; the longer the maturity maturity-specific subset of the index.
of a security, the greater the effect a change in interest rates is likely to have
on its price. Lower-rated bonds may be subject to greater risk than ICE BofA Index Information:
higher-rated bonds. No investing strategy can overcome all market volatility Source: ICE Data Indices, LLC (“ICE”), used with permission. ICE PERMITS
or guarantee future results. USE OF THE ICE BofA INDICES AND RELATED DATA ON AN “AS IS”
BASIS, MAKES NO WARRANTIES REGARDING SAME, DOES NOT
Statements concerning financial market trends are based on current market GUARANTEE THE SUITABILITY, QUALITY, ACCURACY, TIMELINESS,
conditions, which will fluctuate. There is no guarantee that markets will AND/OR COMPLETENESS OF THE ICE BofA INDICES OR ANY DATA
perform in a similar manner under similar conditions in the future. INCLUDED IN, RELATED TO, OR DERIVED THEREFROM, ASSUMES NO
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This commentary may contain assumptions that are “forward-looking Indexes are unmanaged, do not reflect the deduction of fees or expenses,
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The credit quality of the debt securities in a portfolio are assigned by a
presented herein. If you are an individual retirement investor, contact your
nationally recognized statistical rating organization (NRSRO), such as
financial advisor or other non-Lord Abbett fiduciary about whether any given
Standard & Poor’s, Moody’s, or Fitch, as an indication of an issuer’s
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appropriate for your circumstances.
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and below are lower-rated securities (junk bonds). High-yielding, non-invest- The opinions in this commentary are as of the date of publication, are
ment-grade bonds (junk bonds) involve higher risks than investment-grade subject to change based on subsequent developments, and may not reflect
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sectors, and/or markets described were or will be profitable. Investing
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does not warrant the accuracy and completeness of the information.
One basis point equals one one-hundredth of a percentage point.
Investors should consult with a financial advisor prior to making an
Carry represents the additional return accruing to an investor from holding a investment decision.
higher yielding security over a lower yielding security, assuming prices
remain constant.
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