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May 3, 2013 4:44 pm
Apple product launches typically come with queues around the block. This week the corporate bond market witnessed the same kind of frenzy for Apple’s record iBond.
Apple sold bonds worth $17bn, the world’s largest corporate debt sale, as the iPhone-maker raised capital to finance a $100bn cash return to shareholders and avoid a large tax bill for repatriating cash from its non-US operations.
But investors looking to hop on the corporate bond bandwagon following the iBond should take note: in the history of modern finance, people have never been paid less for lending to companies.
Demand for corporate bonds has been insatiable for the past six months, driven by central bank bond-buying. This has left global corporate bond yields, which move inversely to bond prices, at all time lows.
But while corporate treasurers are moonwalking around their own boardrooms every time they see how cheaply they can borrow, this does not necessarily mean that buyers are not happy, too.
“People can get too hung up on absolute yield,” says Iain Stealey, portfolio manager at JPMorgan Asset Management. “The reality is that in relation to cash, and in relation to government bonds, corporate debt continues to look quite attractive.”
A typical investment grade corporate bond pays 3 per cent a year, which is better than 1.7 per cent for US Treasuries.
Investors are being paid 2.4 per cent on Apple’s 10-year debt and 3.9 per cent for the 30-year debt. Moreover, falling inflation in the US and eurozone bolsters the case for owning fixed rate debt.
Fund managers and credit analysts preach caution, however, for those looking to jump feet first into the corporate bond market.
For a start, most believe that the sharp increase in bond prices has largely run its course.
“We are entering the stretched phase of the credit rally, that’s for sure,” says Valentijn van Nieuwenhuijzen, head of strategy at ING Investment Management.
“Flows are still supportive, but the upside has largely gone, now.”
Returns on global “junk” corporate bonds last year were a massive 20 per cent, while returns on investment grade were 11 per cent.
Bond prices can continue to grind higher, but simple maths means the scope for capital appreciation is limited by the already low level of interest rates.
With yields so low, investors can be forgiven for thinking the whole party could start to unravel over the coming years, should economic growth accelerate and central banks first stem their purchases of government bonds and ultimately look to tighten policy.
Rising sovereign bond yields would pull corporate bond yields along for the ride.
“Should there be any hint that the Fed will be taking its foot off the accelerator; investors could run the other way,” says Jack Ablin, chief investment officer at Harris Private Bank.
The flip side, however is that bond prices could also fall sharply if the economy gets much worse, because the corporate default rates – which for months have been hovering around historic lows – might start to rise.
“We are in a sweet spot for credit at the moment, but either substantially weaker or stronger growth in the future are both potential dangers that could upset the market,” says Alan Capper, a credit strategist at Lloyds.
A third concern is that, when prices do start to turn around, it could happen swiftly. Post-crisis regulation has left banks less able to hold corporate bonds on their own books and act as market-makers, meaning liquidity can more easily dry up in a downturn.
And trading volumes are low as well, meaning it can be hard to exit positions at the best of times, particularly in the smaller names.
Of the 30,000 investment-grade corporate bonds trading in the US, only 20 trade more than 10 times a day, according to MarketAxess. The proportion of the market that turns over in a year has slipped below 75 per cent.
However, for retail investors looking for a place to park cash, or for pension funds looking to match assets to liabilities, it may not really matter how the bonds are trading or how much liquidity there is.
As long as investors are happy for their iBond to last longer than their new iPhone, they can just hold on to the debt for 10 years, collect the 2.4 per cent and assume that one of the world’s biggest companies will pay them back when the time comes.
And for the time being at least, there is momentum in the market. At the start of the year investors feared the emergence of higher interest rates, but that threat appears slim for now as the global economy shows signs of slowing.
It helps explain the rapturous demand for the iBond.
“Any time a high quality issuer such as Apple comes to the market, you will see tremendous demand from investors,” says Ashish Shah, head of global credit at AllianceBernstein.
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