U.S. corporate bonds are gaining interest among foreign investors, especially in the eyes of European pension funds. This is a vote of confidence for U.S. creditworthy companies.
 
In today’s low-yield environment, investors are constantly searching for better returns. But they also want to do this in the safest possible way. In other words, they want to take on the least amount of risk they can afford.
 
With Japanese yields having been depressed for some time and a year of lower negative yields in Europe, both European and Japanese investors have been flocking to U.S. bonds. A lot of the newer Japanese investors previously had their capital in the European bond market but are now shifting their capital to U.S. bonds.  
 
That’s because if you take a look around the world, in our opinion, the U.S. is among the most attractive markets, providing both the return profile and risk mitigation that investors demand.
 
So far, European interest has been focused on U.S. investment-grade corporate bonds, an asset class that they consider safe. Investment-grade bonds tend to have a lower default rate in comparison to many other types of credit assets.
 
It isn’t only the low default risk that’s attracting foreign investors on their U.S. quest for yield. Investors are favoring investment-grade corporate bonds because it’s also a case of the familiar. At the end of the day, when European investors go across the Atlantic to buy investment-grade corporate bonds in the U.S., they are essentially buying into a similar market as themselves.
 
In short, a company that can issue an investment-grade corporate bond is typically large and going to behave like companies in its size category. This means credit analysts would look at these companies in a common manner. Even though there will be differences in local markets, the risk factors impacting a large corporation in Europe would be comparable to ones impacting U.S.-based companies.
 
When there’s a sudden surge of interest in a particular asset class, there are often questions that arise about how these capital flows could affect other markets. While the increased investment in U.S. corporate bonds by European investors might not directly translate to shifts in the investment-grade bond market, this could have an impact on currency markets.
 
Some European investors may invest in U.S. bonds unhedged to take advantage of the higher yields as well as the strengthening U.S. dollar. Others enter into currency swaps to avoid taking on currency exposure. These hedging activities may impact the cross-currency basis swaps pricing, but we do not anticipate a significant impact on the U.S. dollar as a result of this.
 
Another question investors may have is whether the heightened interest can overheat the asset class. We believe rising interest in U.S. corporate bonds is unlikely to stretch the market. Looking at the big picture, the U.S. market is a very deep market.
 
If you look at the credit index, there’s about $5.3 trillion in bonds outstanding. Every year, bonds are maturing and new bonds are being refinanced. Over the past several years, there’s been more than a trillion dollars of issues in investment-grade bonds alone.
 
The point is, the U.S. market can easily absorb the funds that are coming its way. And when there are steady flows coming to the market, it creates a positive backdrop to help support spreads and pricing.
 
International investors’ healthy appetite for U.S. bonds are generating flows out of Europe, but on the flip side, U.S. companies (and Asian companies) continue to issue bonds in Europe. The influx of capital going from Europe to U.S. bonds right now is a chase for yield. Eventually, there’s going to be a self-balancing mechanism because money flows everywhere. We just have to keep an eye on where it’s heading.


Charles Tan is a portfolio manager/analyst on Aberdeen's U.S. fixed income team. He joined Aberdeen in 2005 from Moody’s Investor Services, where he was a senior analyst covering U.S. high-yield industrial companies and Asian financial institutions. Previously, he worked for First Commercial Bank of Philadelphia as a credit officer.