The Ubs Group is Bullish on Investment-grade Corporate Bonds. Here’s Why

Despite a decline in yields compared to the peaks seen last year, investment-grade corporate bonds still present attractive opportunities for income-seeking investors, as highlighted by UBS.

‍

Currently, the effective yield on the ICE BofA U.S. Corporate Bond Index, which monitors the performance of U.S. dollar-denominated investment-grade corporate debt, stands at approximately 5.5%, down from 6.4% in October of the previous year. This fluctuation is in line with the inverse relationship between bond yields and prices.

‍

Barry McAlinden, a fixed income strategist at UBS' chief investment office, explained in a note from late March that the total return on investment-grade (IG) bonds has encountered challenges due to the interest rate component, particularly as Treasury yields have risen since the start of the year, with the 10-year Treasury currently yielding about 4.36%.

‍

However, McAlinden emphasized that the excess return of IG bonds has been noteworthy, with a 1.1% increase year-to-date as of March 22, measured against duration-matched Treasuries. This suggests that holding IG bonds has been advantageous compared to U.S. government bonds.

‍

One contributing factor to this excess return is the robust primary market issuance in investment-grade debt, which has led to an increase in its average market-weighted coupon from 3.65% in 2022 to 4.2%, translating to an income return of approximately 35 basis points per month for IG bonds compared to 22 basis points for Treasuries with a market-weighted coupon of 2.7%.

‍

McAlinden also anticipates that spreads over Treasuries will remain resilient, citing factors such as receding inflation, moderating growth, and healthy corporate profits that are expected to maintain strong demand from IG investors and keep issue fundamentals stable.

‍

Within the investment-grade market, UBS favors the financial sector over nonfinancial issuers and suggests focusing on short- and intermediate-term duration. According to McAlinden, the short end (1-3 year) offers low-volatility carry, while longer duration (7-10 year) should deliver strong performance from a total return perspective, reflecting the anticipation of lower nominal yields by the year's end.

‍

Despite historically tight spreads between A-rated and BBB-rated bonds, the strategist maintains a neutral stance on As versus BBBs due to a benign view on credit fundamentals.

‍

It's worth noting that bonds rated BBB- or higher by Standard & Poor’s and Fitch, and Baa3 or higher by Moody’s, fall within the investment-grade category.

‍