At the start of the week, US President Donald Trump took the capital markets completely by surprise by taking to Twitter threatening to hike punitive tariffs on Chinese imports. This prompted significant falls in equity prices on Monday as well as a considerable widening of risk premia for corporate bonds.
The latter does not have to be bad news for investors. History shows that corporate bonds can often recover much more quickly than other asset classes and are therefore ideal for anti-cyclical investment. “This particular characteristic is illustrated by Euro-denominated corporate bonds. They have suffered losses for two successive years only once in the last 15 year period”, said Per Wehrmann, Head of European High Yield at DWS.
No endless flight from fundamental value
But why does this rather pleasant characteristic exist? The most important factor will be that a bond – provided the issuer does not default – is repaid at a specified time in the future. As a result, as maturity approaches the so-called pull-to-par effect sets in. This means that price approaches the par value. “Unlike an equity, the price of a debt security cannot differ from its par value for an unlimited period of time”, said Wehrmann.
Furthermore, often the recovery in the US high-yield bond market spills over, making anti-cyclical investments in its Euro denominated equivalents worthwhile as well. The reason for the faster recovery of high-yield bonds in the USA is that there is a much broader base of investors specialized in this asset class. In addition on the other side of the Atlantic, there is a much higher number of Value supporters who focus on whichever investment class is currently attractively priced and who are also prepared to redeploy capital in that direction.
Weak economy disciplines companies
And finally, falling prices tend to go hand in hand with worsening economic data and corporate financial figures. That causes companies to almost automatically focus more on the interests of creditors by concentrating on reducing debt and defending credit quality.
At the same time, in a crisis central banks jump to the aid of the economy by reducing interest rates. Such monetary policy support from a Federal Reserve or European Central Bank does increase the attractiveness of investment classes that carry risk premia, albeit slightly time-delayed. At some point investors are compelled to counteract the lower returns offered by high-quality sovereign bonds. “This benefits the corporate bond market as a whole, because high-yield debt securities have often shown above-average growth in the past”, according to Wehrmann.