Recent market volatility has once again refocused investors’ minds onto answering the question of the optimal route to constructing a well-diversified portfolio. The benefits of diversification are always sought, and the recent period has been a stark reminder of these benefits. 

In this research piece, we will first look at recent market events as well as how the Capital Group Global Corporate Bond Fund (LUX) has fared in that environment. We will then lift the lid on the specific characteristics and drivers of market returns for global investment grade (IG) corporate bonds. We also look at how Capital Group approaches these factors and how we seek to add consistent excess returns in this sector over the market cycle. 

Market review 

Global corporate bond markets have returned 2.7% (USD hedged) year-to-date. ¹ On the surface this might seem like a perfectly benign start to a calendar year, dare one even say a good start. However, what this number masks is the tumultuous journey it has taken to get here. 2020 will certainly mark a year to be remembered, not least because of the extreme volatility experienced, but also because of the root cause of the crisis and the resulting abrupt shutdown of large parts of the global economy. Both the speed and magnitude of the downward moves in financial markets seen in a relatively short period of time led to an unprecedented level of support by central banks and governments, which have been relatively swift in their responses to the crisis.

Entering 2020, it was clear that we were in the later stages of the economic cycle, but the year nonetheless started on a relatively upbeat note. The tone soon shifted as news of COVID-19 began to emerge. Risk sentiment deteriorated sharply in March and risk markets sold off aggressively, with equity and credit markets suffering large and sudden declines. As evidenced by the following graph, global corporate bond spreads widened by 228 basis points (bps) since 31 December 2019 to reach 326 bps on 23 March, and the market returned - 7.9% on a USD hedged basis over that period. Yields also rose quickly over the worst period of volatility experienced in March before falling again to end roughly around the same level they started the year at.¹

Global corporate bond spreads and yield-to-worst

Past results are not a guarantee of future results. Data as at 12 June 2020. Source: Bloomberg

 

While initially dominated by concerns surrounding the impact of the pandemic on supply chains and on the leisure and travel industries, the sell-off shifted to being much broader-based as uncertainty about measures to contain the virus as well as the impact from the fall in the price of oil led to a worsening in the global growth outlook. Liquidity also became very constrained. 

Risk sentiment improved as central banks and governments stepped in to help alleviate financial and market stress. Corporate bond markets responded particularly positively to the news that the US Federal Reserve (Fed) was extending its reach to include corporate bonds in its asset-purchasing programme for the first time ever. In fact, volatility dropped and markets began to rally before the Fed even started buying any corporate bonds, whether through exchange-traded funds or directly in the secondary market. The mere announcement that it would do so was enough to help calm the markets. The Fed has also softened any blow of future fallen angels² hampering market returns, by explicitly announcing it could also buy these securities. The European Central Bank (conditionally) followed suit on buying fallen angels. The intervention by central banks helped to not only avert what started as a health crisis turning into a financial one, but also restored markets to a more or less functioning state while also helping to improve overall market liquidity.

 

1. As at 12 June 2020 as measured by the Bloomberg Barclays Global Aggregate Corporates Index. Source: Bloomberg

2. Fallen angels: Bonds downgraded from investment grade to high yield

 

Risk factors you should consider before investing:

• This material is not intended to provide investment advice or be considered a personal recommendation.
• The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment.
• Past results are not a guide to future results.
• If the currency in which you invest strengthens against the currency in which the underlying investments of the fund are made, the value of your investment will decrease.
• The Prospectus and Key Investor Information Document set out risks, which, depending on the fund, may include risks associated with investing in fixed income, emerging markets and/or high-yield securities; emerging markets are volatile and may suffer from liquidity problems.