The high-grade market looks to be among the best options for bond investors in an overall low-yield environment created by last year's massive Treasury rally, according to several portfolio managers and strategists. They argue that total returns for high-grade bonds will almost certainly be less than last year's 9-10%, they should outperform government securities due to improving corporate credit quality and a reduced supply of new paper.
Less volatility should be one of the themes this year in the investment grade market, says Krishna Memani, global credit strategist at Credit Suisse First Boston. "The economy may not be improving as fast as we'd like, but it's not deteriorating. Investors are more aware of the risks in the corporate bond market both as an asset class and with regard to individual issuers," he says.
The United Nations Federal Credit Union is already overweight the corporate market, but will plunge another $50 million into the asset class once the U.S. engages with Iraq. Christopher Sullivan, portfolio manager of $875 million, says he will look at consumer finance companies such as MBNA Corp. and Capital One Financial Corp., which should benefit as the economy improves.
The prospect of more economic stability is encouraging many investors to go after lower credit quality issues with higher yields. Greg Staples, portfolio manager of $11 billion in taxable fixed-income at MONY Capital Management, sees telecommunications and large cyclical credits such as Ford Motor Co. and Weyerhauser benefiting as the economy recovers. He would not comment on the firm's specific plans, however.
Some argue that simply putting money into cyclical credits in expectation of a recovery could prove dangerous, as the recovery will likely be less robust than it was in the mid-90s. "The profit tide that lifted all boats will be much weaker than it was in the mid-90s, so every single credit won't improve as much as it did then," says Bill Cunningham, director of credit strategy for North America at J.P. Morgan Securities.
Telecom and utilities could be among the wild cards this year. While J.P. Morgan and CSFB have rated them neutral or underweight, Louise Purtle, strategist at CreditSights, believes they could be among the top performers for the year, as regulatory restrictions that stood in the way of consolidation appear likely to be lifted.
Purtle is more optimistic for increased M&A activity than some of her peers, but she shares the other strategists' view that overall corporate bond issuance will drop some 20% to $350-380 billion. Terming out of commercial paper, which was a big part of issuance last year, has largely been done, she says.
This limited supply may have driven last year's late rally in October and November, says J.P. Morgan's Cunningham. He says the rally may dampen the possibility for a large move in 2003. "Investors can't wait till we love the market to start buying. By that time it's too late," he says.
