Wednesday, February 18, 2009
Equities losing out to rising demand for corporate credit
By Paul J Davies Published: February 18 2009 02:00 Last updated: February 18 2009 02:00 Peter Hargreaves, chief executive of the UK's largest retail financial adviser network, last week told Today , the BBC's flagship morning radio news programme, that many of Hargreaves Lansdown's clients had already been piling into corporate credit - and shunning equities. It is a message that has been increasingly repeated in the UK's personal finance pages of recent weeks and fits with the consensus among finance professionals globally that in a long and deep recession, or even just an extended period of low growth, corporate profits and therefore stock dividends are likely to disappoint. If it was credit that got us into this mess it will have to be credit that leads us out - or that at least will have to stabilise first. But, in the old tradition of the City of London, if retail investors have picked up the scent, does that mean the killing has long been made and only carion scraps remain? For once, the answer looks like No. First off, it is not so clear cut whether retail investors are piling in. Europeans, who have long been bigger fans of corporate debt than their UK cousins, were expressing deep revulsion through the final three months of last year, according to yesterday's data from the European Fund and Asset Management Association. These retail investors pulled €69bn ($86.8bn) out of bond funds in the third quarter and €174bn over the full year, which compares with equity fund withdrawals of €27bn and €162bn, respectively. However, some anecdotal evidence suggests that while funds have suffered, individual companies have gained. Bankers at Royal Bank of Scotland said they saw the biggest ever order book for a euro bond sale last week when they got €16bn of demand for a Siemens deal that raised €4bn in two tranches. According to one banker involved, 10-15 per cent of the orders were from equity accounts, private bank network accounts and other retail accounts. Being a strong name in Germany and having ticket sizes as low as €1,000 helped attract this crowd. "When a trade idea turns up in your weekend paper that normally means it's over and done with," says one banker involved in the bond sale. "But this time I would say that it is not yet, corporate credit has a good way to go. Demand for new bonds is as good as we've ever seen it." Whether or not retail investors are getting involved, the professional institutions do not seem to be rushing in - at least not at the expense of equities. "In terms of observed equity investor behaviour, it's fair to say that we've seen very few crossover buyers of high grade bonds to date," says Steve Dulake, European credit strategist at JPMorgan. "Our sense, at least based on our conversations with this community, is that high-grade bond implied rates of return are too low." In mid-November, it was easy to find quite a broad selection of high quality credits that had been beaten up by forced selling. But now, even the simplistic apparent better value of current corporate bond yields versus implied dividend yields might only reflect a premium for the lack of liquidity in bond markets, Mr Dulake says. "The yield advantage which corporate bonds appear to offer over stocks is very consistent with our estimate of the market liquidity premium; as we've said before, this is arguably a function of a lack of available funding," he says. Beyond relative value, investors also have to take into account their view of the likely path of interest rates and inflation. A long period of deflation favours bond investments, whereas a risk of high or hyper-inflation as a result of central bank money printing would favour equities. Morgan Stanley analysts in a cross asset-class assessment this week say their base case is for a temporary spell of deflation. "Massive global policy stimulus will prevent a sustained deflationary spiral; a temporary deflation scare gives way to a return to moderate inflation in 2010," they reckon, although they think inflation will be more volatile. This view indicates to them that investors should prefer cash to equities, while they also recommend being over-weight in investment grade corporate bonds with a bias towards defensive sectors. But would it make any difference to credit markets if equity investors were moving into corporate bonds? There is an argument that, just as with the capital structure of a company, the world's debt markets greatly exceed the size of its equity markets - and equity investors are never going to sell all their holdings. But Jeff Amato, credit strategist at Goldman Sachs in London, thinks that if equity investors are entering the credit markets they could make a difference. "Any decent sized marginal buyer coming into the market ought to have an impact on spreads."