Bond Viewpoint - Don’t be a hero… why you should stick to Investment Grade this year

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Given that the default rate of High Yield bonds is expected to rise yet further in 2009, investors are best advised to focus on Investment Grade bonds for the time being says John Stopford, Co-Head of Fixed Income at Investec Asset Management

The current economic environment is extremely challenging for corporate bonds. The worst economic downturn since the Great Depression has put huge strain on company finances. A clear indication of this is the recent jump in the number of defaults of sub-investment grade bonds. According to Moody’s rating service, in the year to March 2009 almost 7.5% of low-rated companies failed, up from a 2% default rate a year earlier.

Furthermore, a range of indicators suggest that the sub-investment grade default rate could double by the end of this year. This would make it the worst period for defaults since the 1930s.

Our favourite leading indicator of defaults is a survey conducted by the Federal Reserve which asks bank loan officers whether they are tightening or loosening their corporate lending standards. This tends to preempt the default rate by about nine months and at present points to a further sharp rise in junk bond failures with the peak only likely to occur late this year. Other indicators, including the yield pick-up offered by defaultsensitive CCC-rated bonds and models run by the rating agencies, point to a similar outcome.

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