Investors have carried out a “land grab” of corporate bonds, ahead of the ECB beginning its corporate bond buying programme tomorrow.
Mitch Reznick, co-head of credit at Hermes Investment Management, says that the lead-up to the ECB including corporate bonds in its QE program has already had an impact on the corporate bond market.
“The prospect of a determined, deep-pocketed buyer in primary and secondary bond markets has sent credit spreads tighter as it triggered a land-grab for credit,” he says.
In the ECB’s March meeting, president Mario Draghi revealed the asset purchase program, which had previously been focused on government bonds, was being extended to corporate bonds, albeit excluding banks. The programme was also expanded from €60bn a month to €80bn.
The ECB’s inclusion of long-dated bonds may also affect the make-up of bonds issued, says Marilyn Watson, head of global fundamental fixed income strategy at BlackRock. The ECB will buy bonds up to 30-year terms.
“We have already started to see a shift in the maturity of recent new euro corporate bond issuance with an increase in longer-dated supply. This may be the start of a much deeper longer-dated corporate bond market in Europe, which has historically been far smaller than that of the US,” she adds.
Jon Jonsson, manager of the Neuberger Berman Global Bond Absolute Return fund, says there is a danger that the rising market is likely to lift all bonds, regardless of quality.
“There are risks associated with the new program. Companies too small or highly-leveraged to issue high-yield bonds under normal circumstances may be able to do so in this environment, and investment grade companies may be tempted to over-extend themselves – but that has been the case in every bull market in credit,” he says.
“More significantly, the presence of such a substantial new buyer in the primary market is likely to make it easier for issuers to demand more favourable terms from investors, while the purchase program’s eligibility criteria may preclude some investor-friendly characteristics, too.”
However, Mike Della Vedova, manager of the T. Rowe Price European High Yield Bond fund, says that after an initial rush to the market, investors are starting to be more discerning.
While buying immediately after the ECB’s announcement saw demand for investment grade spill over into high-yield bonds, including CCC-rated energy, metal and mining companies, this is starting to ebb, he says.
“This trend eased last month, as the broad market moved more or less sideways. However, this time the higher-quality names came into their own, outperforming riskier credits. This rerating of risk is in line with our thesis that fundamental credit quality is the most important determinant of performance in the long run,” he adds.
The rush to corporate bonds means much of the market is no longer worth buying, adds Reznick. Instead, he is looking to credit default swaps in Europe, which fall out of the ECB’s buying programme, rather than physical credit.
He also believes that US and hard-currency emerging market credit have the potential to outperform European bonds. “We believe global investors will eventually look for opportunities in these markets after tiring of overbought Europe,” Reznick adds.
Bank of America Merrill Lynch adds that while non-eligible assets, or those not included in the ECB buying programme, underperformed in the two months following the ECB announcement, they are now starting to bounce back.
“We have started to see early signs of the catch-up trade,” a report from the bank adds. “Over the past couple of weeks investors have started embracing yield and beta, amid declining yields.”