Spreads for US investment grade companies, for example, are approaching their tightest levels in 20 years which has encouraged the firm to remain underweight on global investment grade credit.
The only other area, out of 14 fixed income subsectors, where it is underweight is Japanese government bonds as it said this is the area where it sees least attractive returns.
“The higher-for-longer rate environment has restored income in a range of different bonds. Total yields on offer in credit – in investment grade, mortgage-backed securities and high yield – provides long-term investors relatively attractive yield returns to risk, especially in shorter-term bonds.
“Within credit, we prefer the income from short- and intermediate-term bonds and pockets that compensate investors for risk-taking. We are neutral high yield credit globally on both a tactical and strategic horizon. The income cushion makes high yield more attractive on a total return basis relative to investment grade, in our view,” the BlackRock Investment Institute (BII) stated in an asset allocation note.
From a regional perspective, the BII favours European long-term credit over that in the US as European spreads are less tight and investors are better compensated for the risk they are taking to hold the asset.
However, it said it was carefully watching the outcome of the French parliamentary election on 7 July as almost 20 per cent of the European corporate bond market is from France. The results last weekend saw a shock win by an alliance of left-leaning parties called the New Popular Front but that party failed to secure a majority which means a coalition is likely required.
“On strategic horizons of five years and longer, we like private credit over public – even as US direct lending default rates have risen, according to Lincoln International data. Defaults could be even higher if not for lender flexibility on companies breaching credit agreements. This factors into our conservative default assumptions for private credit – twice those of public high yield.”
In other areas of its fixed income allocations, BII said it prefers inflation-linked bonds and short-term government bonds, particularly in the UK. It also favours short-term bonds, holding an overweight position, and is neutral on long-term US Treasuries.
Last month, the firm moved overweight on developed market government bonds for the first time in five years as it said this is a “more volatile regime” currently.
“We’re in a new, more volatile regime where macro risks are elevated and valuations are shifting more quickly. Assessing valuations on a strategic horizon of five years and longer is key for long-term investors, even if short-term performance can be driven by other factors.”
