Insight & Analysis

Bonds stirred but investors remain a little shaken

Published: Jan 2023

Corporate bonds may be back in favour with investors, but not every prospective debt issuer will find market conditions to their liking over the coming months.

Bond market participants would have been more than relieved to see the back of 2022. The Janus Henderson corporate debt index noted the cost of issuing new bonds climbed significantly last year as markets repriced to reflect rising inflation, higher central bank policy rates and expectations of further rate hikes to come.

As a result, net corporate debt fell in 2022 for the first time since Janus Henderson started compiling data in 2014/15 despite record levels of operating profits.

At first glance, prospects for companies looking to raise funds this year are much rosier. A survey of 100 professional European investors published by Managing Partners Group in January found around 60% intended to increase their allocation to investment grade corporate debt.

“As focus increasingly moves away from inflation and towards the real economy, we expect interest rate-sensitive asset classes such as investment grade bonds to outperform equities,” says Ben Pakenham, Head of European High Yield and Global Loans at Abrdn. “We expect valuations to re-price to reflect lower earnings in the first half of the year but for any recession to be relatively short lived.”

Lewis Aubrey-Johnson, Head of Fixed Income Products at Invesco refers to recent corporate bond issues being oversubscribed. “As further evidence [of the recovery of the corporate bond market], the UK government has been able to reduce its stock of corporate bonds in a perfectly orderly manner all while yields are declining,” he adds.

Bonds are back after a decade in which equities offered a much more compelling risk/reward profile and yields look attractive, especially if inflation comes down. That is the view of Stephen Snowden, Head of Fixed Income at Artemis Investment Management, who adds the additional yield generated by corporate bonds is generous by historical norms, which should help them deliver better returns.

Positive investor sentiment has prompted a few corporates to enter the market. In early January, Kamco Invest and Gulf Bank announced the successful completion of a KD165m (US$538m) six-year senior unsecured bond issue for Kuwait Projects Company,, the largest Kuwaiti dinar-denominated corporate bond ever issued.

Euro and sterling debt sales for the first two weeks of the year were the highest on record going back to 2000 according to Refinitiv. However, this growth was driven by debt sales by financial institutions – corporate debt issuance actually fell by a third compared to the same period in 2022.

The cost of raising debt has also raised eyebrows. Renault’s internal bank had to offer investors in its euro-denominated notes almost three times the spread offered for a similar deal in January 2022, as did Toyota for its two-part euro-denominated deal compared to what it offered for a similar issuance in late 2021.

Deloitte’s latest quarterly survey of UK chief financial officers found that appetite to borrow and issue debt was lower than at any point since the global financial crisis.

Then there are concerns around the ability of corporates to service maturing debt. Research published earlier this month by financial research firm Calcbench found between 2016 and 2021, interest expenses and total debt among non-financial S&P 500 companies increased by 36% to US$184.8bn and US$5.49trn respectively.

Analysis of 22 of these companies revealed that more than a third of their debt will mature over the next five years at rates between 2.38% and 3.22%. With corporate interest rates currently hovering around 5% percent, the possibility of increased corporate debt default cannot be discounted.

Mark Preskett, Senior Portfolio Manager Morningstar Investment Management Europe describes European credit as being more attractively priced than US credit for both investment grade and sub-investment grade debt, but adds inflation pressures have been particularly pronounced in Europe.

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