Bonds investors don't just find "safe havens" in government bonds

Investors have been fleeing into government bonds in droves, driving their prices higher as the global banking system has recently become more turbulent. But what about the bond market? Volker Schmidt, Senior Portfolio Manager at ETHENEA Independent Investors, classifies the situation.

Corporate bonds denominated in euros have performed similarly to government bonds since the beginning of the year. Risk premiums are on average back to where they started the year, with the fall in premiums seen in the first two months of the year being reversed in March. In addition, issuers outside the banking sector have performed better and are also showing lower price fluctuations.

However, the overall economic situation has changed with the problems and the emergency sale of Credit Suisse. “Expectations of further rate hikes remain but the magnitude may be lower than previously expected. Banks are becoming more restrictive in lending because uncertainty about economic developments has increased and refinancing has become more expensive and less secure for banks,” says Schmidt.

Although the ETHENEA expert considers the European and US economies to be very robust, the vulnerability of the global banking system could affect the global economy. “The performance of corporate bonds will be significantly influenced by the development of the sub-group of financial issuers. Non-financial issuers remain very resilient as they have significant cash reserves, have enjoyed stable demand and have been able to de-congest their supply chains,” explains Schmidt. Accordingly, both non-financial issuers and government bonds are safe havens for investors in the current situation.

Company fundamentals as the starting point for any investment analysis

"Looking back at 2022, both well-known indices, the Bloomberg Euro Aggregate Corporate Total Return Index and the Bloomberg Euro Aggregate Treasury Total Return Index, posted double-digit losses," notes Schmidt. However, the fund manager highlights that the Corporate Index outperformed the Treasury Index due to lower interest rate risk and its shorter average duration of 4.59 versus 7.29. “Although risk premia increased over the year, corporate bonds outperformed government bonds in the final quarter of 2022. In particular, speculative corporate bonds below investment grade were the best choice among the bad alternatives due to shorter maturities and higher coupons,” summarizes Schmidt.

Bonds from real estate owners also collapsed last year because their business models depend heavily on cheap and sustainable refinancing. "When that source of funding dried up, investors started shedding their bonds and yields skyrocketed," explains the fund manager. If investors now believe in real estate companies' ability to find reliable sources of funding, Schmidt says it could be an attractive entry point.

Finally, the fund manager makes it clear that investors need to be aware that not all companies will ultimately survive. Therefore, company fundamentals should be the starting point of any investment analysis. “A bright spot among property owners are companies with warehouses and sorting centers on their books. Currently, renting this type of property provides the owner with an inflation-indexed and relatively secure cash flow as demand for warehouses and distribution centers remains high and solvent tenants are able to accept higher rents,” explains Schmidt.

Volker Schmidt
Volker Schmidt

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