Bernard McGrath points out that the rise in interest rates and bond yields means that attractive opportunities can now be found in bond segments such as high yield, European bank subordinated debt and floating rate issues.
For the past five years, Bernard McGrath has been a member of the bond management team at Swiss asset manager Union Bancaire Privée (UBP), an activity that represents CHF 16 billion in assets under management in the group's various strategies. Previously, he was also responsible for managing funds invested in sovereign bonds at Zurich Insurance .
Taking advantage of the correction
"It is clear that bond strategies have had a difficult time since the beginning of the year, with the tightening of monetary policies in Europe and the US. This change in direction has brought an end to a bull market that lasted almost 40 years, with some segments experiencing significant declines."
Bernard McGrath points out that it is appropriate at this time to become more constructive again in the bond markets after the rise in yields in recent months, particularly in certain segments of the corporate debt market. "We believe that the bulk of the upward movement in yields is now behind us. There are opportunities now, particularly in the corporate debt segments."
"In bond markets, correction periods quickly lead to capital losses. But what fundamentally differentiates corporate debt from equity markets is that correction periods lead to higher yields that will allow investors to recover their initial loss more quickly through carry. In particular, he points to the favourable outlook for segments such as high yield and subordinated bank debt.
High yields
On high yield debt, he points out that valuations have started to reflect a long and protracted recession, which is the main risk to most asset classes today, but is not the central scenario. "If growth is expected to slow and even eventually turn negative, we believe it will essentially be a technical recession of small magnitude."
"But at the same time, the financial position of high yield issuers remains generally good. None of the major sectors is facing financial stress, so we do not expect a material increase in defaults in the short to medium term, with the default rate expected to remain around 2-2.5%. So the yields that are currently available are extremely attractive."
He particularly likes the prospects for oil group debt given the high oil prices, as well as utilities because of their ability to pass on rising costs to customers.
Sound banking
Bernard McGrath also highlights the current attractiveness of European bank subordinated bonds. As a reminder, subordinated bank debt comes after custodians and senior bank debt in the event of default (and before shareholders), a risk that is traditionally compensated by a yield that will be significantly more attractive. "While subordinated debt is technically a high-yield issue, the effective risk of these issues is that of the issuer, which is generally investment grade with low default risk.
"Since the great financial crisis, bank capital has strengthened significantly, with balance sheets that are now more robust. Here too, the widening of credit spreads has allowed entry levels to be restored to attractive levels, particularly for national champions compared to second or third tier banks.
Floating debt advantage
Finally, he points out that the outlook also remains favourable for a segment such as floating rate debt, despite the large flows into this asset class in recent months. "The upward movement in policy rates is not yet over for the next few months, and this remains a very popular class for clients in the current environment to hedge against movements in the 10-year rate, as it is perfectly in line with the decisions that are currently being made by central banks."
Within UBP's bond fund range, a number of funds could perform well in the current circumstances, including Morningstar's four-star funds such as UBAM - Euro Dynamic Bond (ISIN: LU0132662635) and UBAM Global High Yield Solution (ISIN: LU0569863243), or the UBAM - Hybrid Bond fund (ISIN LU1861452677).
