Some money managers that buy junk bonds have been pouring money into investment-grade notes instead, because the yields can be almost as high now.
The difference between yields on the highest-rated junk debt, in the BB tier, and the weakest investment-grade debt, with a BBB rating, has narrowed to relatively thin levels as many investors grow increasingly optimistic about the economic outlook and buy riskier securities. It’s the latest sign of how Federal Reserve rate hikes that started in 2022 aren’t cooling down some markets.
Now some money managers are taking the opposite side of the trade, and buying high-grade bonds instead: at about 1 percentage point as of Thursday, the gap between average BB and BBB yields is narrow compared with its peak of more than 4 percentage points during the pandemic. The difference has been trending downward since October.
“We are going up there and finding good credits with comparable spreads and yields to high-yield bonds,” said Michael Best, a portfolio manager at Barings. His firm owns more investment-grade bonds than it ever has in its high-yield strategies.
Similarly, the portfolio that Connor Fitzgerald oversees at Wellington Management is “favoring high-grade BBBs right now,” he said. His firm was heavily weighted in BB credits during 2022 and 2023 but has been reducing that position.
These money managers are waking up to prices that look unusually high in junk bonds. Within the industrial sector, the share of BB rated companies trading at BBB levels is near the highest outside of periods of market stress, Yuri Seliger, strategist for Bank of America, wrote in a recent report. The difference between the 25th percentile of BB industrial spreads and 75th percentile of BBB industrial spreads is just 15 basis points, “about as low as it gets historically,” he wrote.
“In investment grade, for your BBBs you are making as much spread income as BBs are offering,” Seliger said in an interview. “Why own those if you can buy BBBs and get a very similar spread?”
Kathy Jones, chief fixed-income strategist at Charles Schwab, also thinks BBBs look attractive, partly because the economy could deteriorate as interest rates stay high.
“Even the top end of high yield, at some point, if we hit a bump in the road with the economy those spreads will likely widen,” she said.
For now, US workers and businesses have been holding up surprisingly well as the Federal Reserve has kept interest rates high to tame rising costs. There are signs of weakness emerging, particularly in recent data on consumer sentiment and factory activity, but few predict any kind of serious contraction on the horizon.
Narrow spreads have tempted junk-bond investors into the pool of barely-blue-chip companies before, and some do not see the same opportunities now.
“We currently believe the best value is in BB,” said Taylor Huffman, a client portfolio manager at PT Asset Management LLC.
If spreads widen between those rating-adjacent bonds, the ones with longer durations in the investment-grade space will get hit harder, she argues.
Others are not as concerned about that outcome, or else too tempted by the risk-reward calculation in front of them.
“There is not that much of a gap between the credit quality of BBB and BB,” said Wellington Management’s Fitzgerald. Compared to historical spreads, he said, BBs look “very rich.”
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