BBBackstop
Still, Monday’s outflow was small compared to the billions of dollars poured into LQD since the Federal Reserve announced it would buy credit ETFs to help stabilize markets amid the coronavirus turmoil.
While central bank buying has slowed in recent months, the widespread expectation is that it would ramp up purchases again if more turmoil hits. Both investment-grade and high-yield spreads to Treasuries have tightened to near pre-pandemic levels.
Meanwhile, companies have a strong motivation to maintain their investment-grade status, even at the lowest tier, and will trim their leverage levels if necessary, reckons Academy Securities’ Peter Tchir.
“Most will work hard to retain BBB because it means access to unfunded revolvers, commercial paper, etc. These companies have a lot of levers they can pull,” said Tchir, head of macro strategy. “Companies can go back on the ‘debt diet’ if they need it.”
‘Be Diligent’
All the same, evidence of nervousness was growing even before Monday’s record flow.
Investors pulled nearly $500 million from LQD on a single day last week, which was then its biggest one-day withdrawal in a month. In the junk bond space, the $23.7 billion iShares iBoxx High Yield Corporate Bond ETF (HYG) posted a $3.7 billion exodus in its worst week of outflows since late February.
Regardless of the Fed’s support, bonds lower down the investment-grade scale risk undercutting the performance of credit portfolios, according to strategists at Citigroup Inc. Even BBB bonds that have not yet moved into the BBB- bucket tend to underperform during economic downturns and have a much narrower demand base from quality-conscious investors, they wrote last month.
“IG portfolio managers should be especially diligent in vetting bonds seen as ‘solid BBBs’ during recessionary environments,” wrote Daniel Sorid and James Keefe. “At the first sign of weakness, they can widen along the steepest portion of the IG credit quality spread curve into low BBB.”
This article was provided by Bloomberg News.