"Who in their right mind would move to credit?" wonders Phil Galdi, New York-based managing director of fixed-income quantitative analysis and portfolio strategy. He notes that while spreads on corporate and agency debt, as opposed to global government bonds, have potential to compress, investors cannot rely on past performance in this new, uncertain era. "Rating agencies are not impressed: just this year 14% of corporate bonds were downgraded and there has been $88 billion of defaults, many from investment grade companies," he notes.
This is a burning question for many Asian pension funds and insurance companies looking to expand investment overseas, or seeking to improve lacklustre returns on global bond indices. Government yields are at all-time lows and the introduction of the euro means fewer opportunities for currency hedging.
Falling yields on government bonds is not just a problem for Japanese government bonds, Galdi says. JGB yields have fallen over the past decade from 9% to 0.6%, a dramatic fall, but US and European government bond yields have also fallen to levels where JGBs were in 1995. Assuming no rise in Japanese interest rates, Galdi says returns based on an index of global sovereign bonds will return only 1.3% this fiscal year. Excluding yen investments, this return rises to 4.5%, but this is still just over half the yield that international investors could receive just a few years ago.
So, despite rising credit spreads, corporate downgrades and mounting defaults, "A transition to credit now would help performance," he argues. The bottom line is that corporate yields have upside potential; government yields do not.
Galdi says pension funds and other institutions have been slow to change to credit investments, particularly internationally, but many are considering it. "In five years, global credit indices will dominate global government indices," he predicts.
