The holding that corporate bond funds are most excited about now is cash.
With investment-grade company debt having notched gains of 3 percent this year, money managers like Vanguard Group Inc. and Loomis Sayles & Co. say there are fewer bargains around, and they are reluctant to keep buying. Corporate bond funds held their highest level of cash at the end of March in two years, according to data from Morningstar Inc. Trading volumes in the securities dropped in April as did new offerings.
The high cash levels underscore how difficult it is for fund managers to navigate a decades-long bond rally that may be due for a correction. Investors are still buying at least some of the debt. Money keeps flowing into corporate credit funds, which added $3.75 billion in the week ending May 17 across junk and investment-grade, according to data provider Lipper. But more and more, investors are sitting on incoming money until prices get a little more reasonable.
“We have lots of dry powder because volatility is low,” said Greg Nassour, co-head of investment-grade portfolio management at Vanguard. “If you don’t have enough, it becomes harder to pull the trigger when opportunities present themselves," he said. Vanguard manages $4 trillion of assets.
The list of situations that could spur a market correction is long. Oil prices, Chinese economic growth, tightening from the U.S. Federal Reserve, European elections and trends in U.S. consumer consumption are all possibilities, according to Matt Fey, director of research for Franklin Templeton’s corporate and high-yield group, who said his team is monitoring these factors and others.
Morgan Stanley analysts warned investors in a note this month that returns may stay low in 2017. The surge in bond sales that accompanied easy monetary policy has sparked higher leverage, longer duration and weaker credit ratings across issuers, they wrote, and these factors may mean credit is closer to reaching its peak than traders believe. They’re recommending investors hold higher-rated assets to improve liquidity.
Painful Correction
Whenever corporate bonds do weaken, it can be fast and painful for investors. Risk premiums, or the extra yield over Treasuries that investors demand for holding corporate bonds, jumped almost half a percentage point for investment-grade bonds during the worst of the oil rout at the beginning of last year.
A steep drop like that is what some investors are waiting for.
“We’re trying to be patient,” said Brian Kennedy, a money manager at Loomis Sayles, which oversees $250 billion. He said he’s been holding more reserves in the past three to four months and selling off riskier holdings like convertible bonds. “The low level of yields overall has made it a little bit more difficult to find individual securities that you find really attractive.”