For a good decade, the yields offered by U.S. sovereign debt have become extremely meagre, reaching only a few times the 3% for the ten years. In the face of these depressed returns, the differential offered by high-yield debt proved attractive. Thus, while their presence in our portfolio has remained limited to maintain risk levels close to our objectives, they have nevertheless provided an interesting performance surplus. As far as corporate bonds, the story is the same, but giving the existing mix and the profile of our portfolio, they continue out of our selection.
The aid of all kinds
Regarding the pandemic, the political power has set up many business support programs to preserve the country production industry in the face of a shock as important as unexpected. The idea was to protect employment and make it easier to restart businesses (and thus economic activity) once the shock caused by the pandemic had passed. And it worked well.
In 2020, the number of corporate bankruptcies registered in the United States was undoubtedly the highest since 2010. But the wave of defaults that many expected and total bankruptcies - including personal ones - was even the lowest in 35 years, a sign that the aid has kept afloat many companies and individuals who would have had difficulty surviving under normal conditions.
The other significant aid came from monetary policy
In March 2020, the interest rate differential between the U.S. government and high-yield debt exceeded 10%, while corporate debt exceeded 3.5%. Levels that made corporate financing untenable. The U.S. Federal Reserve, therefore, intervened massively in the debt markets, buying corporate debt. This strategy reached its peak with the purchase of debt from the fallen angels. These companies were once placed in the investment categories but returned to the class of high-yield debt (or speculative debt, or junk bonds) following the pandemic.
This supported the price of these assets, offering them extraordinary performance. Over three years, the three USD-denominated bond positions performed best among all the bond positions present in our investment universe. Corporate bonds have gained nearly 22% over this period, while sovereign debt and high-yield debt play roughly equally, with growth rates of around 19%.
Our choices
Nevertheless, we are entering a new phase. On the one hand, the Fed is discussing its exit strategy. But, on the other hand, sooner or later, debt buybacks will begin to be reduced, removing a significant growth driver from the U.S. bond market. Moreover, the impact will be considerable for corporate bonds and high-yield bonds since, given the normalization of the economy, the aid granted to companies will also emerge from the scene.
A second factor is related to the yield differential between sovereign and corporate debt. At current levels, it is at its lowest level since 2014, and upstream, they had only experienced a similar story in 2004. In terms of high-yield debt, it is at its lowest level since 2007.
Investors are paying very little for the risk incurred, while the support provided to companies is withdrawn. In addition, of course, investors are betting that, with the fast-growing U.S., the number of bankruptcies will remain low. But given the very high valuation level of equity markets in the United States, periods of nervousness during which investors traditionally seek refuge in government bonds are plausible. That is why it is our central position representing 15% of our portfolio.
In high yield bonds, the surplus yield they offer always ensures their place (currently 5% in the portfolio).
With the evolution of the yields in the U.S. bond market and risk-reward, we privilege our portfolio and maintain a short position in High Yield bonds. Conversely, we stay out of U.S. Corporate Bonds.