BNP Paribas constructive over corporate bonds

In the current scenario of low interest rates and weak global growth, the credit market looks relative attractive, according to Alain Krief, head of long only corporate credit management at BNP Paribas Asset Management.

While uncertainty over sovereign debt and global growth has reduced yields on top-rated sovereigns to an all-time low, with the 10-year German Bunds yielding just 1.35 per cent, European investment grade corporate bonds are generating 3.5 per cent on average, while high yield bonds are yielding around 8 per cent.

“Corporates have deleveraged their balance sheets significantly over the past year and are in a good position today,” explains Mr Krief.

Also, since 2009 most companies have refinanced themselves by issuing medium-term debt, which was cheap as the interest rate was very low. “This means that if there is a headwind, it is not a big deal for corporates, because they have secured funding for five years, whereas sovereign issuers need to deal with their debt pretty urgently now,” he says.

In core countries such as Germany, France or even the UK and the Netherlands, a maturity of five to seven years is favoured, but in peripheral countries the focus is on short-term maturity bonds, especially for financials.

“We like banks in Spain or Italy, but we buy short-dated bonds of these banks, as they are covered by the ECB’s three year loan of LTRO (long-term refinancing operations) since last December,” he says. “In financials, we focus on senior debt, where there is inner value and much less risk.”

Industrials, which have refinanced massively, offer good value, in particular blue chips such as Siemens, Eon, or Saint Gobain.

In Europe, which is struggling with very low growth rates, it is important to target global players, which tend to source a growing percentage of their revenues from outside their domestic markets. “Global players must be privileged,” says Mr Krief.

European investment grade is recommended to investors as a core asset class, but for those interested in a more defensive solution, the French firm offers an investment grade corporate fund investing in the industrial and utility sectors only. The exclusion of financials, heavily affected by politicians’ actions and ECB’s decisions over the past two years, enables portfolio volatility to be considerably reduced, he says.

On average banks are rated A+ and they yield 3.5-3.7 per cent, while corporate industrials are rated an average A-/BBB+ and generate around 2.7 per cent.

“The paradox is that the market is telling you that safety is with industrials but the rating agencies are telling you the opposite,” says Benjamin Conquet, investment specialist, credit at the French firm. “However, the trend is that banks are getting downgraded and industrials are getting flat. So there is a convergence.”

FLEXIBLE ALLOCATION

Going forward, the main risk for credits is linked to slowing global growth. “If the US goes back into recession, that is a major risk for credits,” says Mr Krief. The winning recipe is not to take big bets against the benchmark, to have a flexible asset allocation and anticipate market moves.

“In particular, if Germany or France decided to support political and fiscal union, growth may resume over the next six to 12 months. But then it is important to start buying now; we have to always anticipate market moves.”

Whether Greece will stay in the eurozone or not is a very important political and economic issue, but not so relevant for corporate bonds, says Mr Krief. “In our corporate bond fund we do not hold greek issuers. Moreover, the Greek market is small for most of the big corporate and therefore the impact of an exit would be limited for the corporate issuers, but it would be more significant for banks.”

A top down approach is important to determine sector and country allocation, but the companies’ fundamentals are critical in selecting securities, he says.

“It is the bottom up approach that generates outperformance today. We have to be very careful in security selection, as at the moment any corporate with bad financial results is punished by the market very quickly.”

The French firm expects high yield default rates to be close to 3 per cent at the end of the year, versus close to 5 per cent over last 20 years on average. In times of recession, the default rate can hike to 12 to 15 per cent. “We are still very far away from a recession environment in terms of default rate, both for high yield and investment grade,” adds Mr Conquet.

Benjamin Conquet, BNP Paribas Asset Management