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Tight corporate bond spreads could become even tighter through the balance of 2021, predicts Brian Kloss, a portfolio manager with Brandywine Global Investment Management.

Kloss said spreads will widen eventually, given generous governmental fiscal spending and easing of pandemic restrictions, but in the meantime, there could be further tightening.

“Coupled with a growing economy, we think spreads are probably near their tightest,” he said. “But we don’t see any reason for them to widen dramatically [in the short term] and you could still get a little bit of spread tightening.”

Overall, however, he said he is constructive on corporate credit.

“We would actually argue that you should be shorter on the curve,” he said. “You should be focused on those procyclical types of names: commodities [and] basic materials, and if you want a little bit of safety, you can throw in some of the health care technology as well.”

Explicit support for investment-grade corporate credit throughout much of 2020 should provide implicit support for longer-dated and even lower-quality bonds. He suggested some investment-grade bond spreads could see another 20 basis points of tightening, and below-investment-grade bond spreads could tighten by 50 to 100 basis points.

“If you can pick up some incremental yield in the corporate space, we think you’re going to be well compensated for that over the next 12 months,” he said.

He acknowledged some sectors are already benefiting from changing competitive landscapes and business models, which could lead to a bifurcated market. And fiscal support will eventually come to an end, which could lead to slower economic growth.

“At some point, we’ll probably hit some type of recession,” he said. “Or it may not quite be called a recession, but that will start to see a spread widening at some point.”

Interest rates will play a big role in the fate of corporate bonds.

“It depends on exactly how fast rates rise,” he said. “If that pace is too quick, that could create an issue for the underlying corporates, which then would lead us into some type of spread widening.”

He suggested some investors may choose to minimize interest rate risk by buying shorter-term debt or by shorting Treasuries or other safe-haven duration assets.

For strong corporate bond opportunities, Kloss said he favours the commodity sector, especially copper. Demand for the metal will rise as countries move to new sources of electrification, upgrade their grids, and provide new infrastructure for electric vehicles.

“We’ve actually been able to capture what we think has been very attractive returns through both investment-grade allocations toward [Arizona-based] Freeport-McMoRan Inc. and below-investment-grade toward First Quantum [Minerals Ltd. of Vancouver],” he said.

The hospitality sector is also likely to see rapid growth.

“We do believe that recreational or leisure travel will come back, and we think there could be attractive opportunities for investors,” he said.

Riskier sectors include retail, which was undergoing fundamental shifts prior to the pandemic.

“We were moving to online shopping. Shopping was changing,” he said. “Overall, that’s probably a more challenged sector.”


This article is part of the Soundbites program, sponsored by Canada Life. The article was written without sponsor input.

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