(Bloomberg) -- Historically tight spreads and the prospect of a turbulent landing for the US economy have left the world’s second-largest asset manager, Vanguard Group Inc., leery of junk bonds.
“We’re actually relatively cautious on high yield at the moment from a broad perspective,” said Colleen Cunniffe, head of global taxable credit research at Vanguard.
Despite expecting a “bumpy ride” for the US economy over the next six to 12 months, Vanguard sees opportunity in bonds rated CCC, the lowest tier of junk, Cunniffe said during the Bloomberg Intelligence Credit Edge podcast recorded on Tuesday.
Click here to listen to the full interview with Vanguard’s Cunniffe.
Risk assets have rallied this week as Donald Trump’s reelection raises the prospect of tax cuts and looser regulation. Vanguard confirmed in an email Thursday that the result had not changed its outlook on credit markets or the economy.
The riskiest slice of corporate debt has been afflicted with the spread of so-called creditor-on-creditor violence as borrowers exploit weak covenants to force losses on holders. While that could get worse, loopholes in documentation are being addressed to boost investor protections, according to Cunniffe.
“Your analysis has to include a lot more legal analysis, a lot more understanding of your documents and what options are available,” she said.
In high-grade debt, Cunniffe expects credit spreads to remain compressed as US GDP growth trends above 2%, unemployment remains low and inflation moderates.
“Things can stay tight for extended periods of time,” said Cunniffe. “We’re looking for income, so buyers are attracted by yield.”
Investment-grade debt spreads fell to the lowest since 2005, at 77 bps, on Wednesday. Yields rose to 5.2%, well above the 10-year average of 3.6%.
Vanguard prefers debt rated BBB, the lowest-rated part of the blue-chip bond market. Companies with better ratings are more likely to do acquisitions that boost leverage, said Cunniffe.
“Triple B issuers show both commitment and levers around their ratings,” she said. “We have more concern in the higher-quality space.”
By sector, Vanguard likes utilities on better bond valuations compared with broader industrials. Cunniffe also sees opportunity in US financial sector debt, which trades slightly wider than the investment-grade market despite solid fundamentals and a potential boost from interest-rate cuts.
In structured products, Vanguard likes asset-backed securities, particularly shorter dated ones, and those in the auto sector.
“It offers access to diversified collateral and a structure that gives you a lot of security,” Cunniffe said of the ABS market. “It trades attractively relative to other asset classes.”
On the podcast, Cunniffe also discussed:
- Opportunity in commercial mortgage-backed securities
- Leveraged loan valuations and recovery rates
- European credit versus US
- The impact of consumer stress on US banks’ asset quality
- Credit markets in Australia, Turkey, Colombia and China
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