Opportunities in short-dated investment grade credit
January 2023
Marketing Material
First steps back into credit
As renaissance dawns for the fixed income market, short-dated investment grade bonds offer a good re-entry point into credit.
Written by
Ermira Marika
Head of Developed Markets Credit
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Bonds are back! After being starved for yield in the era of low interest rates and quantitative easing, the tide finally seems to be turning for fixed income investors. With central banks hiking rates to combat inflation, the resulting sell-off in bonds has seen valuations return to attractive levels. The aggregated Bloomberg Global Investment Grade Corporate Bond Index, for example, now yields over 5 per cent, hitting levels not seen since the global financial crisis.
Consequently, investment grade bonds have also once again become competitive on a relative value basis, offering income that exceeds the pay outs from some of the world’s highest dividend-paying stocks (see Fig. 1).
Fig. 1 - "Income" is back in fixed income
Dividend yields versus bond yields, %
Source: ICE indices, Bloomberg, Pictet Asset Management. Data covering period 31.12.2009-31.12.2022.
But today’s complex macroeconomic and monetary backdrop requires prudence from capital allocators. Inflation could prove sticky, and it is not yet clear when the US Federal Reserve or the European Central Bank might call time on their monetary tightening campaigns. Furthermore, the global economy is still relatively weak, which could put pressure on company fundamentals in the more stressed corners of the market, notably low-quality, CCC-rated high yield bonds.
Superior compensation
So where should investors go for their first steps back into corporate bonds? One area where yields offer superior compensation against risks is developed markets short-dated credit.
Fig. 2 - Flattening curves
Spread between 10+ year and 1-3 year EUR IG bonds, bps
Source: ICE indices, Bloomberg, Pictet Asset Management. Data covering period 31.12.2012-31.12.2022.
Rising interest rates and tightening monetary conditions have resulted in the flattening – and in some segments the inversion – of investment grade yield curves.
That means investors can secure higher yields for shorter-dated maturities than for longer-dated ones, whilst reducing exposure to duration risk.1 This is crucial in a volatile and uncertain rate hiking cycle.
Although shorter-maturity high yield credit also exhibits attractive valuations, the potential for economic distress in the months ahead suggests investors should perhaps focus on high quality bonds and more defensive industry sectors.
Even within investment grade credit, there certainly is a case for avoiding the more cyclical sectors, such as retail. Defensiveness and a focus on quality are key to navigating today’s environment.
Spread protection
The investment case for 1-3 year investment grade bonds is all the more compelling as this segment is well-placed to deliver attractive returns even if spreads widen further thanks to elevated yields and a lower duration (see Fig. 3). Such resilience is particularly valuable in an uncertain monetary and macroeconomic environment.
Fig. 3 - Elevated yield plus low duration
Expected 1-year returns on global 1-3yr IG, %
Source: ICE indices, Bloomberg, Pictet Asset Management. Calculated using index yields and spread duration (G1BC Index). Data covering period 31.12.2017-31.12.2022.
Sovereign benefits
Value can also be found at the short end of sovereign curves. In the US, for example, 2-year Treasury bonds are yielding some 70 basis points more than their 10-year peers – a gap not seen for 40 years. Similar trends are in play in euro zone and Swiss government bond markets.
Fig. 4 - A blended approach
Yields versus maturity for US IG and Treasuries, %
Source: Bloomberg, Pictet Asset Management. Data as at 31.12.2022.
As credit investors, adding short-dated government bonds not only enhances diversification – and thus reduces risk – but crucially creates additional sources of return amidst inverted sovereign curves.
Adopting a blended credit-sovereign approach enables investors to lock in elevated yields whilst maintaining a lower duration. We believe this is an attractive risk/return proposition during this volatile phase of the credit cycle. Short-dated bonds can therefore act as the perfect starting point on the road back into credit.
Pictet's short mid-term bond strategies
Simple, short-dated, pure investment grade strategies with roughly 50/50 splits between government bonds and carefully selected corporate bonds.
Plain vanilla investment grade: no high yield, no hybrids, no subordinated debt, no emerging markets, no ABS or MBS.
Average duration typically around 1.5 years, with no positions in maturities of over 4 years. USD, EUR and CHF strategies.
Ermira Marika is the Head of the Developed Markets Credit at Pictet Asset Management since 2022. She has been working in Fixed Income for over 20 years.
Before her current position she was the Head of the CHF Bonds team since 2013.
Prior to that Ermira was a quantitative analyst in the Fixed Income team responsible for developing fixed income solutions.
She started her career at Pictet Asset Management as a quantitative analyst in equity strategies.
Prior to Pictet Asset Management, she gained experience in various companies including UBS and Morgan Stanley Capital.
Ermira Marika holds degrees in Business Administration and Economics and Finance from the University of Geneva and is a Chartered Alternative Investment Analyst (CAIA).
Ermira is member of the International Capital Market Association Regional Committee Switzerland and the Swiss Exchange Bond Index Commission.
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