Corporate bond yields have been a boon for income investors. They began rising last year as the Federal Reserve increased interest rates. For many, investment-grade corporate debt is the sweet spot right now, and still has yields that haven’t been seen in years. Bond yields move inversely to prices. “We think the higher level of yields is appealing and should provide a reasonable buffer against near-term market volatility. Average US IG yields are at historically elevated levels of over 5.5% while spreads are sitting slightly above their long-term average,” UBS wrote in an August 18 note. Investment-grade companies will also manage better than non-investment grade ones as a total of $2.42 trillion debt becomes due over the next couple of years, said Vishy Tirupattur, chief fixed income strategist at Morgan Stanley. Investment-grade bonds are rated Baa or above by Moody’s or BBB and above by S & P and Fitch. While the Fed hasn’t closed the door on further hikes, it has indicated rates will remain higher for longer. That means refinancing debt at higher interest rates. “The higher quality companies, investment-grade companies are in such a solid position,” Vishy Tirupattur said. “You could get to 5% to 6% type of yield numbers, without taking much credit risk, without taking much duration risk.” For a typical B3/B- company that wants to refinance their existing debt now, the interest expense it will be incrementally paying will be 50% to 80% higher than what it is currently paying, Tirupattur noted. “That will really weigh on the lower-rated companies that are already struggling,” he said. Those higher interest expenses and tighter lending conditions are among the reasons Fitch Ratings expects high-yield defaults to trend higher, ending the year in a range of 4.5% to 5%. Marc Kremer, portfolio manager and research analyst for Franklin Templeton Fixed Income, also believes investment-grade bonds are an opportunity to get really good yields in a high-quality sector. He manages the Franklin Investment Grade Corporate ETF. “There should be lower spread volatility compared to other [corporate bond] sectors such as high yield, floating rate loans and emerging markets as well,” he said. Where to invest Michael Kessler, senior portfolio manager at Albion Financial, focuses mainly on investment grade corporates for his clients and doesn’t feel he has to necessarily own every corner of the fixed income market. Albion’s diversified corporate bond portfolio is a seven-year ladder of investment grade bonds. “We’re consistent and conservative when it comes to fixed income,” he said. “We are not trying to make some kind of duration bet or hoping rates fall significantly. We are perfectly happy to live in an environment where most or all of the Treasury yield curve is north of 4%.” A high-quality, seven-year bond portfolio yielding an average 5.5% and his firm’s inflation forecast over that same period at around 2.5%, he pointed out. “I’m getting close to 3% real in a high-grade bond portfolio. That is fantastic,” Kessler said. He’s also leaning up a bit in quality these days, around single A bonds. “It doesn’t make sense to be aggressive in terms of taking more credit risk when spreads, which is the compensation you are getting for taking that credit, is it at best average right now,” he explained. The average investment-grade credit spread is about 110 basis points, he said. Here are some of the bonds Albion has been buying for client portfolios recently. Kessler believes they offer a solid real return profile relative to the associated duration and risk. For Morgan Stanley’s Tirupattur, high-grade corporate bonds in financials, particularly the big banks, are compelling. He doesn’t include regional banks in that call, given the new supply expected to hit the market. On Tuesday, U.S. regulators released plans to force regional banks to issue debt as part of their effort to protect the public in the event of more failures. When it comes to duration, Tirupattur likes bonds between one and five years. Investors can also get exposure to the corporate bond market through funds. There are several options, some of which are tied to an index and others which are actively managed. Funds are very liquid, but in times of volatility there have been a lot of outflows. For Franklin Templeton’s Kremer, diversity is really important — and that’s where actively managed funds come in. “Being in a fund structure gives you the ability to have professional management and diversification. It is difficult to replicate that on your own,” he said. Kremer stays close to the benchmark in terms of duration, which is around 7 years right now in the fund. He prefers a more defensive, up-in-quality position and likes utilities, consumer products, health care, pharmaceuticals and food and beverages. — CNBC’s Michael Bloom contributed reporting.
