Breckinridge sees further tightening in US corporate debt spreads after wild bond market swings in H1


Fixed income managers have seen a hectic first half of the year in 2020. In the US, a typical year’s worth of new issues was printed in the space of just four months, as the onset of the pandemic forced companies to take urgent action to shore up their finances.

Spreads also widened dramatically as investors fled riskier assets in favour of ‘safe havens’ like money market funds, cash, and gold.

USD corporate bonds provided equity-like returns in the second quarter of the year, with The MSCI USD Investment Grade Corporate Bond Index returning 8.4 per cent, after having fallen 2.5 per cent in the first quarter. The MSCI USD High Yield Corporate Bond Index meanwhile returned 12.1 per cent after a 14 per cent Q1 drop.

“There have been amazing returns in bond spreads on corporate bonds, around 250 basis points tighter from the widest spreads that we saw earlier in the year. The year to date gross issuance through the end of the second quarter was about even to what we've seen in your full annual issuance numbers in years past,” says Laura Lake, CIO of Breckinridge Capital Advisors, reflecting on the wild swings that characterised the fixed income market in the first half of the 2020. 

Breckinridge is a dollar-denominated fixed income asset manager, with USD40 billion in assets under management from institutional and high net worth individuals. After 25 years managing municipal and corporate bond portfolios, Breckinridge sees the value in taking a long-term view. 

Breckinridge started the year with a higher weighting in government securities. “As a firm, we typically don't try to time the market from an interest rates perspective,” she says, adding that this meant Breckinridge was defensively positioned.

“When we went into 2020, a global pandemic was not our base case, to be honest. But we did go into it conservatively positioned, because we were late-cycle and we thought that valuations were tight. You really weren't getting paid to take on a lot of risk.” 

This positioning allowed Breckinridge to take full advantage of surging issuance and the dramatic widening in corporate bond spreads. The Fed’s bond-buying at the front end of the curve has since helped tighten spreads dramatically.

“The widening that we saw in March and April with the onset of Covid and the shutdown of the global economy hasn't fully reversed, but we're getting close to that. The Fed has really changed the dynamics in the corporate market, and it's just hard to see a scenario where that reverses near term. So, we think that spreads will continue to tighten as we move through the rest of this year,” adds Lake.

Lake says that while there are benefits to shorter term strategies, “when you’re trying to time the markets from a rates perspective, it's very easy to get it wrong”.

She continues: “For a lot of folks, there's something to be said for staying the course in your asset allocation. When you think about the beginning of this year, I don't know if anyone would have said, ‘Hey, 30-year Treasuries are the place you should be investing in.’ Interest rates were already low, and it seemed like, how much lower could they go?”

Year-to-date returns on 30-year US Treasury bonds is 31.46 per cent, which is higher than most equity returns. Investors expect interest rates to stay low or fall further, meaning the value of pre-existing bonds with higher interest rates increases. Moreover, as an economic slowdown looks more likely, the safer assets like government bonds could perform better than equities.

Lake cautions that even the shortest-term ‘safe’ assets like cash are “not risk-free”. 
“The absolute level of yield is even lower than if you're in a short or intermediate duration strategy. Cash can go negative, we've seen it happen in Europe. So it's not that if you're just holding cash, your worst-case outcome is zero. The worst case is it actually does go down.”