Are there opportunities among the BBB debt mountain?
The explosion of lower-ranked investment grade debt globally since the credit crisis has created interesting opportunities alongside the well-flagged risks, according to Kames Capital’s head of fixed income Adrian Hull.
Concerns are growing over the ever-increasing glut of BBB-rated bonds after a wave of fresh issuance pushed its share of global debt markets to near half of the total in issuance.
This has led investors to focus on the potential impact of rising interest rates and how it could become increasingly expensive to issue and service this debt if they continue to climb.
Hull adds the sheer level of debt has also spooked investors who are concerned that some companies appear to be on a credit binge.
“In the second half of 2018, the increase in BBB debt became a thing,” he says. “It suited the narrative around wider credit spreads, weaker equity markets, higher US rates; a self-fulfilling prophecy of debt-filled doom.”
However, Hull says this focus on net debt misses a key point; namely that there is so much debt simply because it is cheap for companies to issue it.
“This isn’t anything new: what we see today has been the case for a number of years. There is more debt for a number of reasons, but one of them is definitely because it is cheap.”
Rather than fear the expansion of debt issuance from companies, Hull says as long as companies can service the debt there remain plenty of opportunities for investors.
“As homeowners in the UK and elsewhere know it is not the nominal amount of debt that matters (per se), but rather the ability to service that debt,” he says.
“As government debt has ballooned over the last 10 years gilt funding costs have significantly decreased, supported by zero interest rate policies, quantitative easing and the low/non-inflationary environment. Better rated corporates whose funding costs are “spread” to governments have thus benefited too, along with less well rated credits as investors hunted for yield.”
But Hull warns that: “Too much debt drags on both corporate and government balance sheets alike. But whilst the two are inextricably linked the solutions are potentially very different and investors must be selective when it comes to their choice of IG bonds.”