Risk selloff led to a wild quarter across fixed income
In the depths of panic over the COVID-19 pandemic,
markets seized as investors rushed out of risk assets and
into cash and U.S. Treasuries. At the epicenter of the slide
was an effort to sell any asset that could be liquidated.
Equity markets declined sharply as uncertainty over
earnings and liquidity made visibility over valuations
difficult. Credit markets experienced a painful unwinding
of leverage that was felt across a broad swath of
instruments. Investment grade, high yield and emerging
credit all experienced widening credit spreads and price
declines at an unprecedented pace as did other parts of
fixed-income markets, including mortgages, commercial
mortgage-backed securities and municipals.
Within credit, high-yield bonds suffered the most
as investors worried about the impact from the
economic shutdown on low-quality borrowers. Sellers
outnumbered buyers and bid-ask spreads approached
250 basis points (bps). The bid-ask spread is essentially
the difference between the highest price a buyer is
willing to pay for an asset and the lowest price that a
seller is willing to accept.
Among sectors within high yield, energy experienced
the sharpest contraction as the pandemic’s impact was
exacerbated by falling oil prices, when what began as an
expended demand shock was compounded by Russia’s
lack of cooperation with OPEC in cutting oil production,
and then Saudi Arabia’s reaction to increase its own
production punitively. Energy securities posted their
worst quarter on record, losing nearly 50% over the
course of three months.
Investment grade and U.S. treasuries
Similar to the pullback experienced within high yield,
investment-grade credit spreads were volatile in the first
quarter of 2020. Credits spreads measure the difference
in yield that a corporate bond offers relative to a U.S.
Treasury security with a comparable maturity. The spread
is meant to compensate investors for the additional risks.
From the start of the year to the end of the quarter,
investment-grade credit spreads, as measured by the
Bloomberg Barclays U.S. Corporate Bond Index, widened
massively from 93 bps to 272 bps, a level not seen since
the 2008–2009 financial crisis. Intra-quarter, the spread
on the index reached 373 bps before rallying into the end
of the first quarter.
Despite the volatile first quarter, U.S. Treasury securities
performed well as yields fell and investors sought out
safe havens. From the beginning of the year to the end
of March, the yield on the 10-year U.S. Treasury fell
125 bps from 1.92% to 0.67%, while the yield on the
2-year U.S. Treasury fell 132 bps from 1.57% to 0.25%.
This was driven by the Fed cutting rates twice in March,
ending the quarter with a target range of 0–0.25%.
As the stock market sank into a bear market at the fastest
pace in history, the Fed dramatically increased efforts to
save the economy, promising to do “whatever it takes” to
ensure liquidity. Fiscal policy followed suit and Congress
quickly passed the $2.2 trillion CARES Act. The equity
and fixed income markets rallied on the news.
Ivy Securian Core Bond Fund Portfolio Managers Tom
Houghton and Dan Henken noted that policymakers
recognize this is a multi-pronged challenge — a correction
in valuations, a liquidity squeeze, a collapse in energy
prices, an upturn in defaults stemming from cyclically
high corporate leverage and COVID-19-specific shocks.
In aggregate, the policy response has exceeded the actions
taken during the Global Financial Crisis.
The Fed’s intervention consisted of several programs,
- For the first time in history, purchasing investment-grade
and high-yield corporate bond ETF securities
- Main Street business lending program setting a target
of $600 billion in loans for mid-sized businesses
- Municipal Liquidity Facility offering up to $500
billion in lending Payroll Protection Program to
help small businesses
The Fed is poised to buy various asset classes, except equities,
and has made clear progress in opening the corporate debt
market, which had been illiquid until it stepped in. Purchases
by the Fed have brought credit spreads lower and normalized
fixed income trading.
The Fed’s moves have also unleashed large amounts of new
issuance. Despite the substantial increase in volatility over the
past few months, investment-grade bond supply increased as
companies rushed to issue longer term debt to term out shortterm
funding, as well as ensure liquidity through this difficult
economic period. In fact, as markets loosened starting March
23, investment-grade bond issuance in the quarter ended up
49% relative to the first quarter of 2019. For the month of
March, issuance was up 129% year over year and surpassed
the prior monthly issuance record from May 2016. In high
yield, issuance rose in the quarter although not to the same
extent as investment grade.
Lastly, economists are struggling to get a handle on the
length and depth of a recession during a pandemic as well as
the impact of a forceful policy response. Projections for gross
domestic product vary widely for second quarter 2020 with
estimates ranging from 9% to -40% annualized growth, and
full-year 2020 estimates of -1% to -6%.
While the U.S. job data shows how deep the incoming
recession may likely be, some investors are hoping that
additional stimulus from the Trump administration will
further cushion the blow. It appears the market is looking
broadly through a flattening of COVID-19 cases and the shortterm
economic damaged caused to a recovery starting in the
latter half of 2020. In April, we saw the best one-month equity
return in decades, and the best two-week period since the
depths of the Great Depression. Broad market increases again
followed in May. With the “Great Lockdown” beginning to
wind down, as investors, we need to balance this view with the
reality that we still need to get through the earnings hole.
From the outset, we have been framing this environment
in the context of three pillars: the public health impact, the
economic impact and the impact on the markets. It is hard
not to look at this environment without including a fourth
factor: political implications. The decision to reopen is not
just science driven; there will be political influence as well.
With this backdrop, within fixed income, we believe
investors are showing more appetite for investment grade
and high-yield corporate bonds, the latest sign of easing
credit-market conditions and potential for solid performance
ahead. We surveyed several Ivy portfolio managers to get
their thoughts on fixed income positioning:
- Ivy Crossover Credit Fund Portfolio Manager Ben Esty
stated: “While we have long been cautious on the corporate
credit market due to our views that excesses had built
up, we now believe the combination of the valuations
and stimulus programs, most principally the program to
purchase investment-grade bonds by the Fed, has created
an attractive environment to take risk in the asset class.”
- The Ivy Asset Strategy Fund team, which can invest
across the asset class spectrum commented: “Within fixed
income, we have a strong preference for investment-grade
credit. This is an asset class which sold off heavily in
mid-March as leveraged unwinds drove spread widening
in violent fashion. Investment-grade companies tend to
have large liquidity buffers and credit metrics which help
them to withstand economic shocks. In a world where
most of the U.S. Treasury curve yields less than 1% and
companies are cutting dividends, we believe the search for
income will drive investment grade credit spreads tighter,
providing good opportunities for total return.” We also
recognize that should spreads move higher, however, the
value of investment-grade corporate bonds could still fall
depending on rapidly changing economic conditions.
- Based on history, this is potentially a good time to invest in
securities rated below investment grade. Ivy High Income
Fund Portfolio Manager Chad Gunther noted, “Spreads
historically rising above 800 bps have led to attractive
return opportunities, and the case is even more profound
above 900 bps. Based on the ICE BofA US High Yield
Index, the average annualized return over the next 1-, 3-
and 5-year periods following the point in which high yield
spreads crossed 900 bps was 11.0%, 11.2%, and 9.9%,
respectively.¹” This illustrates the potential importance
of holding high-yield bonds over longer timeframes,
particularly during periods of heightened market volatility.
- Municipal bonds suffered during the downturn as recent
inflows quickly, and meaningfully, reversed. As with other
fixed income classes, there has been renewed interest here
as well. Ivy Municipal Bond Fund Portfolio Manager Bryan
Bailey indicated, “While we had been proceeding with
caution, expecting the beginning of an outflow cycle that
would exert selling pressure on the municipal market, the
Municipal Liquidity Facility implemented by the Fed has
tempered our immediate concerns to some degree. However,
in the long run, we do not believe that the facility provides
the panacea that will solve all of the market’s problems.”
Bailey expects renewed demand in the space which may
improve valuations versus other investment-grade fixed
income alternatives, as cross-over and non-traditional buyers
have seized on the opportunity now that they are confident
of backing by the Fed. We believe the key driver will be a
renewed and sustained interest by the retail investor, which
comprises approximately 70% of the market.
Given this backdrop, our Firm’s commitment to fundamentally
driven, bottom-up credit research could prove to be a key
advantage in navigating these choppy markets. Our portfolio
managers and credit analysts review each credit to identify
attractive risk-reward potential for our investors.
Stay up to date with the latest views from our Chief Investment Officer
Dan Hanson, CFA
1. Source: Morningstar. Performance calculated when spreads reached 900 bps on the following dates: 12/1/2000, 5/1/2001, 10/1/2001, 7/1/2002, 10/1/2008, 11/1/2011.
Markit iBoxx USD Liquid High Yield Index consists of liquid USD high yield bonds, selected to provide a balanced representation of the broad USD high yield corporate bond universe. Markit iBoxx USD Liquid
Investment Grade Index is designed to provide a balanced representation of the USD investment grade corporate market and to meet the investors demand for a USD denominated, highly liquid and representative
investment grade corporate index.
The Bloomberg Barclays U.S. Corporate Bond Index measures the investment grade, fixed-rate, taxable corporate bond market and includes USD-denominated securities publicly issued by U.S. and non-U.S. industrial,
utility and financial issuers. The ICE BofAML US High Yield Index tracks the performance of U.S. dollar denominated below investment grade corporate debt publicly issued in the U.S. domestic market. It is not possible to
invest directly in an index.
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