By Todd Shriber for Iris.xyz
Discipline is one of the most common and important traits shared by successful investors. Thing is, the more trying a particular market environment is, the more difficult it becomes for investors, even some professionals, to exercise proper discipline.
Such a scenario could be playing out right now in the corporate credit market. As investors fret about the potential for a spate of downgrades coming in 2019 for investment-grade corporate bonds that currently have tenuous grasps on quality ratings, many are departing credit funds. In the world of exchange traded funds (ETFs) three of this year’s 10 worst offenders in terms of assets lost are corporate bond funds, including one investment-grade product.
One way investors can exercise discipline with corporate bonds is to focus on fundamentals, something many basic indexes devoted to this asset class do not do. The newly minted JPMorgan Corporate Bond Research Enhanced ETF (JIGB) could be a game changer for credit investors at a time when fundamentals are taking on added importance.
Actively manged, the JPMorgan Corporate Bond Research Enhanced ETF (JIGB) looks to outperform the Bloomberg Barclays US Corporate Bond Index while maintaining a similar risk profile to that benchmark.
Don’t Get Stung By The B’s
Bonds with BBB ratings are one to three notches away from junk status and those are the bonds causing considerable consternation in the investment-grade universe.
“As of year-end 2018, our total forecast balance sheet debt for U.S. nonfinancial corporates in the ‘BBB’ category has grown to just under $3 trillion, up roughly 171% since 2007,” said Standard & Poor’s (S&P). “Moreover, industry consolidation and acquisition activity have created sizeable debt concentrations among certain sectors and issuers, which could pose risks given the larger amount of debt relative to past cycles.”
Many passively managed corporate bond strategies are heavily allocated to BBB-rated debt. More than half the corporates residing in the widely followed Markit iBoxx USD Liquid Investment Grade Index sport BBB ratings.
As an actively managed fund, the JPMorgan Corporate Bond Research Enhanced ETF (JIGB) is not constrained by index requirements and can focus on the most appealing credits, based on risk-adjusted expectations. JIGB’s managers can overweight the bonds from issuers with top-tier credit ratings while underweighting or avoiding issuers with lower ratings.
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Avoiding credits that are currently rated investment-grade but flirting with high-yield status could prove rewarding in the next downturn, which could bring downgrades for $200 billion to $250 billion to bonds currently sporting BBB ratings.
“The $200 billion-$250 billion estimate includes all nonfinancial sectors, including more highly leveraged sectors such as real estate (primarily REITs) and regulated utilities, which accounted for nearly 30% of ‘BBB’ fallen angels in the financial crisis,” said S&P.
As a result of the tighter regulatory environment and increased capital requirements that followed the global financial crisis, financial services firms often dominate investment-grade corporate bond strategies. The Markit iBoxx USD Liquid Investment Grade Index devotes over 27 percent of its weight to bonds issued by that sector.
Other sectors, including real estate and utilities, dominate the universe of highly levered BBB-rated corporate debt. Some investors have been willing to overlook that because real estate and utilities issues often feature favorable volatility traits. Still, of JIGB’s more than 340 holdings, just five are real estate issues.
Another sector to monitor is consumer staples, which took on added leverage during a period of consolidation.
“One sector that stands out as having a larger percentage of ‘BBB’ debt leveraged above 4x due to M&A is consumer products,” said S&P.