Fixed Income Insights: Finding Value in Bonds- A Relative Value Series

‍Averages hide more than they reveal, and in case of aggregated credit spreads on bonds (near record lows), misses the relative value at the sector level within the asset class. Our relative value analysis, within Investment Grade (IG) bonds suggest opportunities in HEALTHCARE, INDUSTRIALS and UTILITIES.‍

Using Option Adjusted Spreads (OAS - excess yield offered by a bond over the relevant maturity risk free rate, adjusted for embedded options), our trend analysis focuses on OAS at the sector level, relative to their own history, thereby eliminating the bias in spread variation caused by duration differences.

Over the coming few weeks, we aim to analyze and surface such relative value opportunities across US Investment Grade, US High Yield and US EM bonds:‍

• Chapter 1 - (today's note) - US Investment Grade Relative Value

• Chapter 2 - US High Yield Relative Value

• Chapter 3 - US Emerging Markets Relative Value

Chapter 1- US Investment Grade Relative Value‍

We scanned through the 11 sectors that make up the universe and concluded that HEALTHCARE,INDUSTRIAL AND UTILITIES offer the highest relative value. This is most likely owing to the capex intensive nature of the industries resulting in higher net leverage. Interestingly, we also observed the following similarities in spread movements in 9 of them, with the exception being Financials (both Subordinate and Senior) as below‍

• Pre-pandemic peak was between Feb/ Mar 2016

• All time high was on March 20^th, 2020

• Post pandemic high was in Oct 2022

• Post pandemic low was on Nov 5^th, 2021.

Basis the above measure, 3 sectors in our opinion offer the best value in the IG universe in order of ranking (see rebased chart).

The above depicts the extent of relative value each sector offers relative to the index in general. It depicts the differential spreads variance relative to the start date.

• USD IG HealthCare OAS

Current spread at 132.24 bps trades at 19.45 bps over its historical average with its all-time low spread being 71.41 bps in May 2014. Bonds in this sector are likely to witness the most spread compression should the US Fed deliver a Soft Landing.‍

• USD IG Industrial OAS

  

  Current Spread at 128.19 bps trades 17.30 bps over its historical average with its all-time low spread being 68.51 bps in Feb 2018.

• USD IG Utilities OAS

  

  Current Spread at 144.75 bps trades 14.03 bps over its historical average with its all-time low spread being 83.38 bps in Feb 2018.

  Conclusion: Investors would do well by adding bonds from the above sectors in their portfolios as they are likely to see the highest spread compression on a relative basis in the US$ IG Universe.

  Read Chapter 2 & 3 here: Fixed Income Insights: Finding Value in Bonds- A Relative Value Series (Part II)

  All investments carry risk, for more important information please read this disclaimer.