Despite a spooky economic outlook, institutional demand for corporate debt continues to grow. Should investors be concerned about zombies in their portfolio?
Defined benefit (DB) pension schemes have turned bullish on ccorporate bonds despite fears that defaults could soon rise.
In the past 12 months, around 30% of final salary schemes have increased their exposure to an average of a third of their fixed income portfolios, with a further 20% telling Aon that they intend joining them.
The attractiveness of corporate debt relative to equities is a factor. Indeed, US high-yield bonds return around 2% above equities, the highest level of divergence since 2008’s crash. Unsurprisingly, the surge in demand has coincided with a spike in issuance with a record $1.9trn (£1.4trn) added to the debt pile in September, according to Refinitiv. This brings the size of the US’ corporate debt market to almost $10trn (£7.7trn), or half the country’s GDP.
Even before the Covid crisis concerns about the sustainability of such debt were mounting on the back of around 50 defaults last year. This figure has more than doubled in 2020, according to S&P Global.
Yet the default rate has been contained by central bank interventions and delayed corporate reporting due to the pandemic.
While France’s reported default levels dropped by 25% year to date, the French central bank warned that this was largely due to delayed reporting as a result of the lockdown. Some countries, including Spain, Belgium and Italy have even changed their insolvency laws to keep default rates low.
Creditors have also been boosted by central bank interventions. The ECB has committed to boosting its corporate bond portfolio by €750bn (£684bn), while the Federal Reserve is to spend $750bn (£580bn) buying company debt. However, the programme expires at the end of the year.
While these policy measures appear to have softened the initial blow of the pandemic, with the expiry of government subsidies across Western markets on the horizon, investors may soon see a return of the zombies, and potential headaches for the years to come.