October return attribution summary
admin | November 1, 2019
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Positive excess return with investment grade credit mostly tighter; rates contributed very little to total return on a round-trip month. Portfolio managers should continue to overweight lower-rated segments with greater risk compensation (OAS), as a flatter yield curve implies global investors will move further out the credit spectrum in USD spread product in an attempt to meet performance hurdles. The consumer non-cyclicals sector (16.3% of IG Index) recommendation is moving to a market weight from an over weight, and basic industry (3.1%) rises to an over weight from a market weight (Exhibit 1).
Exhibit 1. Sector recommendations for remainder of 2019
Compensation for lower credit within IG grinds tighter; but while it might seem that appetite for risk is pricing out BBB credit, the opportunity for moving down in quality has not bottomed, as seen in the lower bound results throughout 2017-2018 (Exhibit 2).
Exhibit 2: BBB vs A Corp spreads (5-year history)
Alternatively, the appetite for the highest tranche of high yield credit (BB) has never appeared higher in recent history, at least in relation to BBB IG credit spreads (Exhibit 3).
Exhibit 3: BB vs BBB Corp spreads (1- to 5-year sector, 5-year history)
Exhibit 4: USD corporate bond supply (amounts in billions)
USD IG supply dropped -14% year-over-year to $86 billion in October, as new issue severely tempered from early September’s record-setting pace. Nevertheless, the performance versus 2018 hardly represents a major drop-off in activity, as Oct ’18 included a one-time, massive $27 billion 12-part new issue from Comcast (CMCSA), which was funding its $36 billion deal for Sky at the time. CMCSA was also among this month’s biggest issuers, but no IG credits brought jumbo deals in October, and only one issuance (WFC post-earnings) even surpassed the $5 billion mark. High yield provided an extremely impressive $25 billion in USD October supply, more than triple last year’s tally for the month – further fueling the +38% increase in volume YTD. Investor appetite for risk has been best illustrated in the high yield market, particularly in the higher-rated BB segment of the market (Exhibit 3).
IG issuance in October was aided by late push over the last week of the month. On Tuesday alone, nine issuers brought just under $17 billion in USD IG debt, led by Comcast’s $4.75 billion in re-fi debt and Danaher’s (DHR: A2*-/A*-) anticipated USD leg of acquisition financing for its $21 billion purchase of GE’s BioPharma segment announced back in February. The five-part launch contributed $4 billion to the haul, and followed its recent launch of €6.25 billion in the euro market. Late new issue in the month also included “highly opportunistic” and high-quality deals with extremely low concessions, and issuers more aggressively targeting costs in their own capital structures via tender/redemption – further terming out maturities and pursuing second, third or even fourth round attempts to target higher coupon issues.
October sector returns
Rates were little changed on a net basis, contributing only 10 bps to October Total Returns (+0.61%) for the IG Corporate Bond Index. The remainder came from tighter spreads, which helped generate Excess Return of +0.51% in October. This month’s additional returns help IG Corps maintain their FI market-leading level with YTD Total Return performance for of +13.9%. After an initial back-up in the first week of October to a wide of +121, the IG Index OAS tightened to +110 at month-end.
Insurance paper (+0.78% Excess Return) took the top spot in the IG Index this month, led by performance in lower-rating constituents, such as AIG, as well as long-dated issues in bellwether names, such as MET and PRU. REITs (+0.76%) were also among top performers, despite or perhaps resulting from several weeks of active new issue from the segment; but also continuing to demonstrate the market’s appetite for BBB credit. Also among the top performers for October was Communications (+0.73), where performance was aided by several high profile recapitalizations, with large-scale tender/exchange efforts helping to drive valuation.
Although Finance Companies (+0.57%) excess returns came out ahead of the Index average in October, it was the first time in recent memory that it was not among the top performers in a positive credit month. The subgroup has been favored by the inclusion of longer-dated legacy GECC paper (GE ‘35s), as well as the rally in Aircraft Lessors throughout the 2nd and 3rd quarters. Renewed Boeing 737 Max concerns diminished spread opportunity were enough to keep that industry at bay. Meanwhile, GE reported positive results late in the quarter, but was not enough to help land FinCos among the top performers yet again.
Not surprisingly, higher-rated, defensive segments made up the bottom of the Index performers for the month, including: Tech (+0.43%) and Capital Goods (+0.39%) and Consumer Cyclical (+0.42%), where the worst performances came from high-rated names such as HD, WMT, AMZN and TOYOTA. Energy (+0.11%) was the single worst performance in the Index (excluding negligible Industrial-Other) amidst some mixed earnings among key names in midstream and E&P for 3Q19. We remain Over Weight on Energy within the IG Index and see the residual back-up in higher beta names as an opportunity to increase exposure.
Exhibit 6: Index performance by rating – September 2019
Exhibit 7: Index performance by maturity – September 2019
IG Corporate Bond Index: 2019 return attribution summary year-to-date
Exhibit 8: Index performance by sector – year-to-date
Exhibit 9: Index performance by rating – year-to-date
Exhibit 10: Index performance by maturity – year-to-date