Monica Erickson, senior portfolio manager at DoubleLine Capital LP, speaks during the Reuters Global Investment 2019 Outlook Summit in New York, U.S., November 15, 2018. REUTERS/Brendan McDermid
November 15, 2018
By Trevor Hunnicutt and Kate Duguid
NEW YORK (Reuters) – DoubleLine Capital LP portfolio manager Monica Erickson has a problem. She thinks the investment-grade corporate bond market, which is her specialty, is the worst place to be for bond investors.
The investment-grade area includes debt issued by U.S. corporations with the best credit ratings, but it has delivered negative returns this year and underperformed lower-rated “junk” bonds.
“The worst place to be is in the investment-grade corporate market,” Erickson said at the Reuters Global Investment 2019 Outlook Summit in New York. “It’s very difficult to make a case that you want to be in investment-grade.”
It is not that companies all of a sudden cannot pay their bills but that the bonds themselves are particularly sensitive to rising interest rates, Erickson said. DoubleLine is run by closely watched investor Jeffrey Gundlach, known on Wall Street as the Bond King.
The U.S. Federal Reserve has been trying to choke off inflationary pressures by hiking its benchmark overnight interest rate, and markets have also pushed longer-term yields higher.
That is a problem for investors holding bonds that have already been issued and pay a fixed coupon over years that cannot adjust to higher yields in the market. Investment-grade bonds are more vulnerable at the moment than lower-rated debt because higher-credit companies issue bonds that repay at those fixed rates over a longer period of time.
All else equal, as rates rise 1 percentage point, the investment-grade market declines by nearly 7 percent, compared to around 4 percent declines for high-yield, according to Bank of America Corp data.
At the same time the yield on investment-grade bonds over low-risk government debt – the premium investors pay in return for taking on additional risk – is below its 10-year average. Those yields could rise if the economy deteriorates, Erickson said.
Investment grade is also riskier because “triple-B” rated credit – the grade for securities just above “junk” status – has increased dramatically since 2008, from 20 percent of all investment grade credit to approximately 50 percent today, she said. Those companies are at the greatest risk of a downgrade when the next economic downturn hits.
U.S.-based high-yield funds are down 0.22 percent this year, compared to a 2.27 percent decline for a category including investment-grade corporate bond funds, according to Refinitiv’s Lipper research service.
Erickson thinks it can get worse. In a downturn, investors may not be able to exit their fixed-income positions. With the triple-B market worth about $3 trillion, finding a buyer in the $1.2 trillion high-yield market could be difficult.
That said, DoubleLine doesn’t believe a crisis is imminent, seeing a slowdown maybe 18 months away as the Fed attempts to kneecap inflation without hurting the economy.
“Has the Fed ever been able to accomplish a soft landing?” she said.
“There for sure is a risk.”
Erickson has been positioning in bonds less sensitive to rising rates, including bank loans. Those instruments are not like traditional bonds because they typically pay investors more as rates rise.
There are risks in bank loans. Given the loosening standards in investor protections, “it’s the best house in the worst neighborhood,” Erickson said.
“I don’t think it is a defensive play but it is the appropriate play given that rates are going up,” she said.
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(Reporting by Kate Duguid and Trevor Hunnicutt; Additional reporting by Jonathan Stempel; Editing by Jennifer Ablan and Paul Simao)