The moderate-growth environment is favourable for non-investment-grade corporate debt, including high-yield bonds and floating-rate loans, according to a number of players in the fixed-interest arena.
Goldman Sachs Asset Management Asia-Pacific head of fixed income Philip Moffitt said that in the fixed-income space in Australia the starting point was always government and corporate bonds as part of an Australian fixed-income portfolio.
"But, with Australian government bond yields at historic lows, and given the relatively concentrated nature of corporate bond opportunities in Australia, the discussion quite naturally progresses to diversification," Moffitt said.
"Global, high-quality corporate bonds hedged back to Australia offer investment-grade exposure and higher yields and that is certainly a major discussion point that we are having with many of our clients."
Bell Potter Securities head of retail fixed income Barry Ziegler said corporate debt gave clients a higher return than was being offered on cash products, including term deposits.
Ziegler said the big four banks were all advertising term deposit rates of below 4.8 per cent a year for $100,000 deposited for 12 months, while three of the same institutions were paying gross yields in excess of 7 per cent on their listed debt and hybrid securities.
"Listed securities from other large financials and industrials also offer similar yields," he said.
Eaton Vance head of bank loan investments Scott Page viewed the moderate-growth environment as favourable for non-investment-grade corporate debt, including high-yield bonds and floating-rate loans.
"With low default rates and relatively healthy corporate balances sheets in the US, high-yield bonds and floating-rate loans may offer an attractive combination of return and risk for investors," Page said.
Their relatively high coupons could mitigate volatility in total return relative to the broad equity markets. "Moreover, floating-rate loans are typically senior and secured by specific collateral, which generally protects downside in a default," Page said.
As to the pros and the cons, he said floating-rate loans and high-yield bonds were attractive as portfolio diversifiers that could help mitigate the impact of rising US Treasury yields. Intermediate/long-term interest rates may be in a holding pattern for now, but were not likely to give any warning when they did rise.
Correlations of total returns of high-yield bonds (BofA Merrill Lynch US High Yield Master II Index) and floating-rate loans (S&P/LSTA Leveraged Loan Index) with total returns on seven- to 10-year US Treasuries had both been negative for the three-, five- and 20-year periods ended 2011.
This was "especially appealing", Page said, given the spectre of generating negative real returns from investing in historically low-yielding US Treasuries.
"Default rates for floating-rate loans may swing from 1 per cent in 'good times' to a peak of 10 per cent during the crisis years. Even though market prices plunged with all credit instruments during the financial crisis of 2008, investors who held on to their floating-rate loan positions continued to receive positive cash flow, and benefited from an impressive snap-back in 2009," he said.
With the general improvement in corporate balance sheets since the financial crisis, default rates currently are around their historical lows of about 1 per cent."
