Analysis: Corporates’ star waning as investors seek safer bonds

By John Parry

NEW YORK (BestGrowthStock) – As worries mount about the chance of another economic downturn, investors are moving into safer bonds. Corporates, once the hottest asset class, are losing their allure.

Both retail and institutional investors are much more discriminating in their purchases of corporate bonds than they were a year ago. Corporate bonds boasted stellar returns in 2009 as riskier markets rallied back from the brink, but now most company debt is seen as expensive in view of the risk of defaults should the economy slip back.

“Credit is not glaringly cheap,” said James Moore, pensions strategist and executive vice president with bond fund manager Pacific Investment Management Co. (PIMCO) in Newport Beach, California.

The dramatic narrowing of corporate bonds’ yield spreads over Treasuries since the financial crisis has not deterred big institutional investors from buying corporate bonds entirely but has slowed their purchases in recent months, he said.

U.S. investment grade corporate bond yield spreads have narrowed to just over 200 basis points from record wide of 656 basis points in December 2008, when markets were in the depths of the financial crisis, according to Bank of America Merrill Lynch data.

Concerns that the economy could fall back into recession have tempered demand for corporate bonds from big institutional investors such as pension funds, which increased their allocation to Treasuries in recent months.

Among pension plans, “demand a year ago was for dedicated long credit mandates. Now it has moved to long bond mandates: half long credit, half long government,” Moore said.

Safer bonds are now outperforming as investors reduce risk exposure. In the second quarter, U.S. Treasuries returned 4.72 percent versus 3.26 percent for high-grade corporate bonds and a negative 0.07 percent for junk bonds, according to Bank of America Merrill Lynch data.

Government bonds, viewed as a safe haven in times of economic weakness, are increasingly finding favor, driving the benchmark 10-year Treasury note yield recently to 14-month lows below 3 percent. For now, investors are shrugging off the risk that huge government debt issuance and budget deficits will lead to a spike in yields.

There are reasons to go on buying corporate bonds because corporate America is sitting on record amounts of cash, but investors are becoming more selective.

According to Lipper, net inflows to U.S. investment grade bond funds have slowed to $66.0 billion year-to-date from $83.3 billion the same period in 2009. Demand has been even weaker for riskier high-yield bonds, which have seen a net outflow year to date of $516 million, compared with a net inflow of $22.03 billion for the same period in 2009.

Fund managers are favoring higher-rated companies which have ample cash reserves and can generate steady income streams even in a recession. Often they are sticking to shorter maturity bonds because they are wary of the risk of inflation, which would weigh more on longer maturity bond prices.

“I am a big fan of short-term corporate bonds because I believe that balance sheets are really quite good,” said King Lip, chief investment officer with Baker Avenue, an asset management firm based in San Francisco, citing big companies such as Cisco and Microsoft with billions of dollars of cash.

Big institutional investors are still reeling from the losses of the financial crisis. They remain very nervous of the risks inherent in stocks and riskier bonds should the economy and markets head south and are predisposed toward safer assets, analysts say.

PIMCO’s Moore estimates that assets under management at U.S. corporate pension plans, excluding defined contribution plans, have declined to about $1.6 trillion from about $1.9 trillion in late 2007 before the global financial crisis.

Corporate bonds are losing some favor over the near term but over the longer term, higher grade company debt is still likely to benefit.

Investors’ reaction to loss of wealth in the financial crisis and an aging population are redrawing standard asset allocations in favor of both government and corporate bonds, fund managers say.

“Most of the investable assets sit in the pockets of baby boomers who will soon retire,” said Joseph Balestrino, senior portfolio manager with Federated Investors Inc. in Pittsburgh, Pennsylvania. “I don’t think emotionally they can take another big hit.”

As people approach the end of their earning years, many are opting for the comparative safety of bonds, which are less volatile than stocks.

“Bonds and cash will garner more of the equity money,” Balestrino added.

(Additional reporting by Dena Aubin, Editing by Chizu Nomiyama)

Analysis: Corporates’ star waning as investors seek safer bonds