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The withdrawal of funding by central banks and the rise in rates in the US has reduced liquidity in financial markets. Money is being withdrawn, and this is hitting riskier assets such as equities in particular.
This market trend is likely to continue for a while as the US Federal Reserve, European Central Bank and the Bank of England unwind support. We’re not predicting a dramatic downturn in the stock market, but we are suggesting that it’s a good time to diversify equity-focused portfolios by adding corporate credit from highly rated investment-grade issuers.
QUALITY IS KEY
We see a relatively shallow peak in interest rates. One reason for this is that the total amount of global debt has risen so much. This may put a dampener on rate increases because every move up has bigger reverberations in highly levered economies pushing up mortgage costs for homeowners and financing costs for companies and governments.
Slow but steady economic growth in Europe in the last few years has led to improved credit ratings for corporate issuers.
Choosing corporate bonds from large stable issuers is a conservative approach that we believe respects the fundamental qualities of the asset class.
Investment-grade credit can provide yields comfortably in excess of UK Gilts, along with compound interest. That means steady returns and protection from volatility. This adds up to balance and downside protection for a portfolio.
Holding high-quality credit is also a way to stay nimble, as bonds from well-known issuers are highly liquid and pricing is accurate.
AN OVERLOOKED OPPORTUNITY
One such market opportunity we see is in financials debt. Banks are showing improved balance sheets and post-financial crisis regulation is very strong. We see bank debt as attractive, liquid and highly rated.
There’s no doubt that the corporate bond market has been overlooked in the last few years as investors sought out riskier assets in an era of cheap money. We see market dynamics as changing now that we are late in the economic cycle after a lengthy expansion.
We believe that holding high-quality corporate credit is one of the best ways to ensure capital preservation and to generate consistent returns over the long term while providing diversification from equities and reducing volatility in a portfolio. Safe harbour indeed.