Capital Ideas^TM

An uncertain economic outlook and high interest rates are generally not viewed as a positive backdrop for investment-grade (IG) corporate bonds (rated BBB/Baa and above). Yet, a confluence of supportive factors is underpinning this asset class. These include relatively good credit quality, high average starting yields above 5.5%, an overall duration of about seven years and stabilisation of the banking sector.

As a result, credit spreads above US Treasuries have tightened to slightly less than 120 basis points (bps), which is near their 10-year average of 124 basis points.

In our view, while investment-grade credit could come under selling pressure in an extreme risk-off environment - the duration profile of the sector, credit fundamentals that are better than in prior periods of economic stress, as well as sustained demand from investors - should provide a degree of support, limiting downside risk in most scenarios.

Overall, we believe investment grade provides a solid middle ground for portfolios. If the US Federal Reserve (Fed) executes a ”soft landing“ and avoids a recession, investment-grade credit should fare well. And if there’s a ”hard landing“, the drawdown in investment grade should be muted compared to what we would expect to see in equities.

This article discuses why investment-grade credit can provide a compelling long-term investment opportunity.