q3 2017 corporate bond commentary
COMMENTARY
Q3 2017 CORPORATE BOND COMMENTARY KEY TAKEAWAYS • U.S. corporates’ revenues, operating
earnings and margins have recovered after bottoming in mid-2016.
• Regulatory relief may reduce costs
for U.S. banks, and tax reform could benefit some Industrial sectors.
• High buybacks and dividends and soft capex indicate a shorter-term focus, and some ESG risks are rising.
INVESTMENT OUTLOOK Taxes Take Center Stage As bond investors, neither corporate tax rates nor after-tax earnings are typically front-and-center in our minds as key credit drivers. We tend to focus more on other metrics, such as earnings before interest, taxes, depreciation and amortization (e.g. EBITDA) as a proxy for cash flow and a corporation’s ability to service its priority interest payments. However, after-tax earnings are clearly important, as they drive internal capital generation, equity valuation and a corporation’s ability to self-fund its dividend and share repurchases within the context of a prudent capital allocation policy. A potential meaningful reduction in the U.S. corporate income tax rate (e.g. from 35 percent to 20 percent) would be a boon for the after-tax earnings of S&P 500 companies, since the weighted-average effective tax rate is about 27 percent. U.S.-based and domestic-focused corporate sectors (e.g. Transportation, Retail, Telecom and Utilities) could benefit the most, given generally higher effective tax rates than U.S. multinational corporations. On balance, we view the prospect of corporate tax reform as a net positive for IG corporate issuers but the devil is in the details, which are somewhat lacking at this point, and we have little visibility on what ultimately may be implemented. Meanwhile, the U.S. economy is growing and corporate profits are rebounding. U.S. real GDP growth of 3.1 percent in 2Q17 bounced back from sub-2 percent growth in recent quarters while consumer spending and private investment each picked up. With solid U.S economic growth and an unemployment rate nearing 4 percent, we expect one additional rate hike in 2017 as the Fed continues to normalize rates. Still, gross corporate leverage is historically high, a clear risk for bondholders. High share buybacks and dividends and weak growth in capital spending indicate a shorter-term focus while the number of cybersecurity risks and antitrust cases is growing.
TAX REFORM: POTENTIAL IMPACT ON CORPORATES Could Benefit Industrials and Reduce Issuance Limiting the tax deductibility of interest could have significant implications for how large corporations view their long-term weighted-average cost of capital and prioritize capital allocation decisions and policies. Effectively increasing the after-tax cost of debt, while less material in today’s unusually low interest-rate environment, could have profound implications for more-indebted corporations as interest rates normalize over the longer-term. A materially higher after-tax cost of debt capital could reduce the volume of U.S. corporate bond issuance. 1
Q3 2017 CORPORATE BOND COMMENTARY If legislation is passed, it would give corporations the ability to transfer funds held overseas back to the U.S. without incurring a tax liability. This outcome would likely benefit large U.S. multinationals with sizable overseas cash holdings depending on how that liquidity was utilized (e.g. capital expenditures, share buybacks, dividends and/or debt reduction). It could also slow debt issuance over time with less need to issue debt in the U.S. corporate bond market to fund dividends and share buybacks. Accumulated U.S. multinational foreign, overseas earnings are estimated at over $2.5 trillion. While details are uncertain, the proposed tax framework appears designed to levy a tax on companies that maintain jobs and capital overseas for tax purposes and create a financial disincentive to doing so. Growth in U.S. capital investment has also been sluggish in recent years, with capacity utilization considered below the point at which inflationary pressures may arise. While the impact is uncertain, capital intensive sectors such as Utilities, Energy, Transportation and Telecom could benefit from such a change.
STRENGTH: TAX REFORM COULD DRIVE IMPROVED PROFITS Corporate Profit Growth Has Recovered Over the last few quarters, S&P 500 Index companies have reported improved sales and operating earnings growth and margins have recovered after bottoming in mid-2016. Operating income for S&P 500 companies increased by 10 percent (per share) in 2Q17 and 10 of 11 sectors reported positive year-on-year growth. A steady U.S. economy, a weaker dollar and a recovery in European growth are factors that have improved the profit outlook. A potential reduction in the U.S. corporate tax rate would further benefit those U.S. firms that have high effective rates. Figure 2: Robust Corporate Earnings Growth is Forecast
Figure 2: Robust Corporate Earnings Growth is Forecast 16% 14% 12% 10%
CREDIT TRENDS DASHBOARD Upgrade Corporate Profits and Operating Trends
8% 6% 4%
In our Credit Trends Dashboard, we capture our views of the key drivers of IG corporate credit and the incremental shifts in these drivers from quarter to quarter.
2%
t
• Operating Trends: We upgraded our assessment of this key driver from neutral to modest strength. FigureFigure 1: Credit Trends Dashboard 1: Corporate Credit Trends Dashboard Weakness Strength
Economy (U.S.) Regulatory Action Corporate Profits Financials' Leverage Central Bank Accommodation Flows / Technicals Oil / Commodities Event Risk Credit Rating Trends Economy (Non-U.S.) Industrials' Leverage Geopolitical Risk
ME
X X X
E 3Q
18
A 2Q
18
A 18 1Q
E 17 4Q
E 17 3Q
A 17 2Q
A 1Q
17
A
Gross leverage (e.g. total debt-to-EBITDA) for nonFinancial IG bond issuers is at a record high above the previous 2001-2002 U.S. recessionary peak. From a sector perspective, the increase in debt leverage is broad-based and leaves borrowers less resilient to economic shocks. Potential tax-advantaged repatriation of overseas cash could improve liquidity and reduce debt issuance. However, special dividends could also be paid to shareholders. Figure 3: Gross Leverage is Beyond Prior Recession Peaks
X X X X
Figure 3: Gross Leverage is Beyond Prior Recession Peaks 2.5x
X X X
2.0x
X X 1.5x
Summary Operating Trends Capital Sources Management / ESG Risks
t
RISK: IG LEVERAGE AT A RECORD HIGH IS A KEY THREAT Gross Debt Leverage Remains a Risk
• Corporate Profits: We upgraded our assessment of this key driver from neutral to modest strength.
Change Since Last Quarter
16
Earnings Growth (per share, y/y%) Source: Bloomberg, S&P 500 Index, as of September 30, 2017.
Key credit drivers that changed during the quarter include:
WA
4Q
3Q
16
A
0%
X X
1.0x
X
1991-1992
Sources: Breckinridge Capital Advisors, as of September 30, 2017.
2001-2002
2008-2009
2016-2017
t
t
IG Gross Leverage IG Net Leverage Source: Morgan Stanley Research, Bloomberg, as of September 30, 2017.
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Q3 2017 CORPORATE BOND COMMENTARY ESG CONSIDERATION: A MATERIAL RISK FOR INSURERS Catastrophe Losses are Rising
REITs and Basic Industry Led Returns in 3Q17
Catastrophe losses from earthquakes, hurricanes and other weather events have had a significantly negative impact on financial results for insurers. Global insured losses have increased from roughly $75 billion in 1980 to roughly $150 billion in 2016. Insurers are using complex actuarial models to manage and mitigate these risks. Primary insurance underwriters are also utilizing reinsurance transactions to offload their exposure.
The REIT sector, which is primarily BBB-rated, outperformed the intermediate corporate market’s excess return by 43bps in 3Q17. Basic Industry bonds outperformed by 31bps based on wider spreads than the index and a recovery in base metals prices. Capital Goods issuers underperformed the corporate market by 24bps based on M&A activity and expected debt supply. Figure 6: Returns by Sector Favored Cyclicals in 3Q17 Figure 6: Returns by Sector Favored Cyclicals in 3Q17 1.6%
Figure 4: Global Catastrophe Losses Figure 4: Global Catastrophe Losses
1.2%
400
0.8%
350
0.4%
250 200
16
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13 20
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11 20
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08 20
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SPREADS: CREDIT SPREADS CONTINUED TO MOVE TIGHTER Comparable Narrowing Across Quality Spectrum t
RETURNS: CORPORATE MARKET PERFORMANCE Lower-Quality Outperformed in 3Q17 The total return for the intermediate IG corporate market was 1.08 percent in 3Q17, per Bloomberg. However, compared to duration-neutral Treasuries and based on a combination of carry and spread compression, the corporate market generated 68 basis points (bps) of excess return in 3Q17. Lower-quality BBB-rated corporate bonds outperformed the corporate market’s excess return by 24bps. In contrast, higher-quality AA-rated corporate bonds underperformed the market’s excess return by 38bps. Figure 5:
t
Total Return Excess Return Source: Bloomberg Barclays U.S. Intermediate IG Corporate Index, as of September 30, 2017.
Overall Losses Insured Losses Source: MunichRe via CreditSight Report.
t
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Intermediate IG corporate spreads tightened by 8bps in 3Q17 to an average option-adjusted spread (OAS) of 79bps—the tightest level since July 2014. Triple-B corporate spreads tightened 9bps during the quarter, compared to AA-rated and A-rated bonds, which tightened by 7bps and 8bps, respectively. The quality spread between AA-rated and BBB-rated corporate bonds ended the quarter at 69bps—the tightest level since September 2014. Figure 7: Corporate Spreads Continued to Narrow in 3Q17
Figure 7: Corporate Spreads Continued to Narrow in 3Q17 300
Figure 5: by Rating Favored BBBsin in 3Q17 3Q17 Returns byReturns Rating Favored BBBs
250
OAS (bps)
1.4% 1.2% 1.0% 0.8%
200 150 100
0.6%
0.0% BBB Corporates
t
IG Corporates
A Corporates
AA Corporates
Total Return Excess Return Source: Bloomberg Barclays U.S. Intermediate IG Corporate Index, as of September 30, 2017.
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17
7
7
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7
ay -1 M
7
ar -1 M
-1 Ja n
16
16
ov N
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6 -1 Ju l
6 ay -1 M
ar -1 M
-1 6 Ja n
0.2%
6
50
0.4%
t
AA Corporate Index A Corporate Index BBB Corporate Index Source: Bloomberg Barclays U.S. Intermediate IG Corporate Index, as of September 30, 2017. t
3
Q3 2017 CORPORATE BOND COMMENTARY MARKET TECHNICALS: SUPPLY & DEMAND Supply Up but Mergers Down in 3Q17
Figure 9: Domestic and Foreign Fund Flows into the U.S. FigureMarket 9: Domestic and Foreign Fund into the Corporate Bond Have Picked upFlows in 2017 U.S. Corporate Bond Market Have Picked up in 2017
500
IG corporate bond issuance of $377 billion in 3Q17 increased by 2 percent year-over-year. Low interest rates and tight spreads continue to encourage high borrowing. IG new issuance is over $1 trillion year-to-date, the sixth year in a row that issuance has topped that figure. U.S. merger volume of $287 billion in 3Q17 decreased by 25 percent year-over-year reflecting a combination of elevated valuation multiples and uncertain U.S. tax policies. Figure 8: Low Rates Have Sustained High Borrowing, While Figure 8: Low on Rates HaveValuations Sustained High Borrowing, Mergers have Slowed High While Mergers have Slowed on High Valuations
1400 1200
$Billions
1000 800 600 400 200 0 YTD-16
t
YTD-17
3Q16
3Q17
U.S. IG Corporate Issuance U.S. Mergers & Acquisitions* Source: Bloomberg, as of September 30, 2017. * Dollar value includes pending and completed U.S. mergers & acquisitions.
Strong Demand from Domestic and Foreign Investors Solid fund flows have continued, with IG bond mutual funds reporting LTM inflows of $110 billion. Purchases of U.S. corporate and foreign bonds by foreign residents have also been notably strong. Foreign flows have increased, with IG corporate purchases estimated at over $400 billion for the LTM period.
$Billions
400 300 200 100 0 2015 t
2016
LTM 2017
Domestic Long-Term IG Bond Mutual Fund Flows Net Purchases of U.S. Corporate Bond Issues by Foreign Residents Source: ICI, as of September 30, 2017 and Federal Reserve Flow of Funds, as of 2Q17.
BRECKINRIDGE STRATEGY Overweight High-Quality Corporates Credit fundamentals remain mixed, with gross leverage at a record high for IG companies while the forward profit outlook has seemingly improved on more solid economic growth and potential tax reform. A reduction in the U.S. corporate tax rate could especially benefit domestic-oriented firms, and a potential tax-advantaged repatriation of overseas cash could improve multinationals’ liquidity and reduce debt issuance— depending on how proceeds are deployed. Still-elevated share buybacks and weak capex growth are indicative of a shorterterm focus by some management teams, and we continue to closely monitor environmental, social and governance (ESG) risks. Given valuations, we are targeting an overweight to AA and A-rated corporates and an underweight to BBB corporates within the context of an overweight corporate allocation in our government credit strategies. Within the corporate sector allocation, we are overweight the Banking, Pharmaceuticals and Technology sectors. We are underweight Basic Industry and REITs bond issuers. We maintain a modest barbell strategy and are duration neutral in government/credit strategies relative to their benchmarks. t
DISCLAIMER: This material has been prepared for our clients and other interested parties and contains the opinions of Breckinridge Capital Advisors, Inc. Information and opinions are current as of the date(s) indicated and are subject to change without notice. Any specific securities or portfolio characteristics are for illustrative purposes and example only. They may not reflect historical, current or future investments in any client portfolio. Nothing in this document should be construed or relied upon as tax, legal or financial advice. All investments involve risk – including loss of principal. An investor should consult with an investment professional before making any investment decisions. Breckinridge can make no assurances, warranties or representations that any strategies described will meet their investment objectives or incur any profits.This document may include projections or other forward-looking statements, which are based on Breckinridge’s research, analysis, and assumptions. There can be no assurances that such projections will occur and the actual results may differ materially. Other events that were not taken into account in formulating such projections may occur and may significantly affect the returns or performance of any account. Past performance is not indicative of future results. This document includes information from companies not affiliated with Breckinridge (“third party content”). Breckinridge reasonably believes the third party content is reliable but cannot guarantee its accuracy or completeness.
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Q3 2017 CORPORATE BOND COMMENTARY KEY TAKEAWAYS • U.S. corporates’ revenues, operating
earnings and margins have recovered after bottoming in mid-2016.
• Regulatory relief may reduce costs
for U.S. banks, and tax reform could benefit some Industrial sectors.
• High buybacks and dividends and soft capex indicate a shorter-term focus, and some ESG risks are rising.
INVESTMENT OUTLOOK Taxes Take Center Stage As bond investors, neither corporate tax rates nor after-tax earnings are typically front-and-center in our minds as key credit drivers. We tend to focus more on other metrics, such as earnings before interest, taxes, depreciation and amortization (e.g. EBITDA) as a proxy for cash flow and a corporation’s ability to service its priority interest payments. However, after-tax earnings are clearly important, as they drive internal capital generation, equity valuation and a corporation’s ability to self-fund its dividend and share repurchases within the context of a prudent capital allocation policy. A potential meaningful reduction in the U.S. corporate income tax rate (e.g. from 35 percent to 20 percent) would be a boon for the after-tax earnings of S&P 500 companies, since the weighted-average effective tax rate is about 27 percent. U.S.-based and domestic-focused corporate sectors (e.g. Transportation, Retail, Telecom and Utilities) could benefit the most, given generally higher effective tax rates than U.S. multinational corporations. On balance, we view the prospect of corporate tax reform as a net positive for IG corporate issuers but the devil is in the details, which are somewhat lacking at this point, and we have little visibility on what ultimately may be implemented. Meanwhile, the U.S. economy is growing and corporate profits are rebounding. U.S. real GDP growth of 3.1 percent in 2Q17 bounced back from sub-2 percent growth in recent quarters while consumer spending and private investment each picked up. With solid U.S economic growth and an unemployment rate nearing 4 percent, we expect one additional rate hike in 2017 as the Fed continues to normalize rates. Still, gross corporate leverage is historically high, a clear risk for bondholders. High share buybacks and dividends and weak growth in capital spending indicate a shorter-term focus while the number of cybersecurity risks and antitrust cases is growing.
TAX REFORM: POTENTIAL IMPACT ON CORPORATES Could Benefit Industrials and Reduce Issuance Limiting the tax deductibility of interest could have significant implications for how large corporations view their long-term weighted-average cost of capital and prioritize capital allocation decisions and policies. Effectively increasing the after-tax cost of debt, while less material in today’s unusually low interest-rate environment, could have profound implications for more-indebted corporations as interest rates normalize over the longer-term. A materially higher after-tax cost of debt capital could reduce the volume of U.S. corporate bond issuance. 1
Q3 2017 CORPORATE BOND COMMENTARY If legislation is passed, it would give corporations the ability to transfer funds held overseas back to the U.S. without incurring a tax liability. This outcome would likely benefit large U.S. multinationals with sizable overseas cash holdings depending on how that liquidity was utilized (e.g. capital expenditures, share buybacks, dividends and/or debt reduction). It could also slow debt issuance over time with less need to issue debt in the U.S. corporate bond market to fund dividends and share buybacks. Accumulated U.S. multinational foreign, overseas earnings are estimated at over $2.5 trillion. While details are uncertain, the proposed tax framework appears designed to levy a tax on companies that maintain jobs and capital overseas for tax purposes and create a financial disincentive to doing so. Growth in U.S. capital investment has also been sluggish in recent years, with capacity utilization considered below the point at which inflationary pressures may arise. While the impact is uncertain, capital intensive sectors such as Utilities, Energy, Transportation and Telecom could benefit from such a change.
STRENGTH: TAX REFORM COULD DRIVE IMPROVED PROFITS Corporate Profit Growth Has Recovered Over the last few quarters, S&P 500 Index companies have reported improved sales and operating earnings growth and margins have recovered after bottoming in mid-2016. Operating income for S&P 500 companies increased by 10 percent (per share) in 2Q17 and 10 of 11 sectors reported positive year-on-year growth. A steady U.S. economy, a weaker dollar and a recovery in European growth are factors that have improved the profit outlook. A potential reduction in the U.S. corporate tax rate would further benefit those U.S. firms that have high effective rates. Figure 2: Robust Corporate Earnings Growth is Forecast
Figure 2: Robust Corporate Earnings Growth is Forecast 16% 14% 12% 10%
CREDIT TRENDS DASHBOARD Upgrade Corporate Profits and Operating Trends
8% 6% 4%
In our Credit Trends Dashboard, we capture our views of the key drivers of IG corporate credit and the incremental shifts in these drivers from quarter to quarter.
2%
t
• Operating Trends: We upgraded our assessment of this key driver from neutral to modest strength. FigureFigure 1: Credit Trends Dashboard 1: Corporate Credit Trends Dashboard Weakness Strength
Economy (U.S.) Regulatory Action Corporate Profits Financials' Leverage Central Bank Accommodation Flows / Technicals Oil / Commodities Event Risk Credit Rating Trends Economy (Non-U.S.) Industrials' Leverage Geopolitical Risk
ME
X X X
E 3Q
18
A 2Q
18
A 18 1Q
E 17 4Q
E 17 3Q
A 17 2Q
A 1Q
17
A
Gross leverage (e.g. total debt-to-EBITDA) for nonFinancial IG bond issuers is at a record high above the previous 2001-2002 U.S. recessionary peak. From a sector perspective, the increase in debt leverage is broad-based and leaves borrowers less resilient to economic shocks. Potential tax-advantaged repatriation of overseas cash could improve liquidity and reduce debt issuance. However, special dividends could also be paid to shareholders. Figure 3: Gross Leverage is Beyond Prior Recession Peaks
X X X X
Figure 3: Gross Leverage is Beyond Prior Recession Peaks 2.5x
X X X
2.0x
X X 1.5x
Summary Operating Trends Capital Sources Management / ESG Risks
t
RISK: IG LEVERAGE AT A RECORD HIGH IS A KEY THREAT Gross Debt Leverage Remains a Risk
• Corporate Profits: We upgraded our assessment of this key driver from neutral to modest strength.
Change Since Last Quarter
16
Earnings Growth (per share, y/y%) Source: Bloomberg, S&P 500 Index, as of September 30, 2017.
Key credit drivers that changed during the quarter include:
WA
4Q
3Q
16
A
0%
X X
1.0x
X
1991-1992
Sources: Breckinridge Capital Advisors, as of September 30, 2017.
2001-2002
2008-2009
2016-2017
t
t
IG Gross Leverage IG Net Leverage Source: Morgan Stanley Research, Bloomberg, as of September 30, 2017.
t
2
Q3 2017 CORPORATE BOND COMMENTARY ESG CONSIDERATION: A MATERIAL RISK FOR INSURERS Catastrophe Losses are Rising
REITs and Basic Industry Led Returns in 3Q17
Catastrophe losses from earthquakes, hurricanes and other weather events have had a significantly negative impact on financial results for insurers. Global insured losses have increased from roughly $75 billion in 1980 to roughly $150 billion in 2016. Insurers are using complex actuarial models to manage and mitigate these risks. Primary insurance underwriters are also utilizing reinsurance transactions to offload their exposure.
The REIT sector, which is primarily BBB-rated, outperformed the intermediate corporate market’s excess return by 43bps in 3Q17. Basic Industry bonds outperformed by 31bps based on wider spreads than the index and a recovery in base metals prices. Capital Goods issuers underperformed the corporate market by 24bps based on M&A activity and expected debt supply. Figure 6: Returns by Sector Favored Cyclicals in 3Q17 Figure 6: Returns by Sector Favored Cyclicals in 3Q17 1.6%
Figure 4: Global Catastrophe Losses Figure 4: Global Catastrophe Losses
1.2%
400
0.8%
350
0.4%
250 200
16
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14 20
13 20
12 20
11 20
10 20
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08 20
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SPREADS: CREDIT SPREADS CONTINUED TO MOVE TIGHTER Comparable Narrowing Across Quality Spectrum t
RETURNS: CORPORATE MARKET PERFORMANCE Lower-Quality Outperformed in 3Q17 The total return for the intermediate IG corporate market was 1.08 percent in 3Q17, per Bloomberg. However, compared to duration-neutral Treasuries and based on a combination of carry and spread compression, the corporate market generated 68 basis points (bps) of excess return in 3Q17. Lower-quality BBB-rated corporate bonds outperformed the corporate market’s excess return by 24bps. In contrast, higher-quality AA-rated corporate bonds underperformed the market’s excess return by 38bps. Figure 5:
t
Total Return Excess Return Source: Bloomberg Barclays U.S. Intermediate IG Corporate Index, as of September 30, 2017.
Overall Losses Insured Losses Source: MunichRe via CreditSight Report.
t
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Intermediate IG corporate spreads tightened by 8bps in 3Q17 to an average option-adjusted spread (OAS) of 79bps—the tightest level since July 2014. Triple-B corporate spreads tightened 9bps during the quarter, compared to AA-rated and A-rated bonds, which tightened by 7bps and 8bps, respectively. The quality spread between AA-rated and BBB-rated corporate bonds ended the quarter at 69bps—the tightest level since September 2014. Figure 7: Corporate Spreads Continued to Narrow in 3Q17
Figure 7: Corporate Spreads Continued to Narrow in 3Q17 300
Figure 5: by Rating Favored BBBsin in 3Q17 3Q17 Returns byReturns Rating Favored BBBs
250
OAS (bps)
1.4% 1.2% 1.0% 0.8%
200 150 100
0.6%
0.0% BBB Corporates
t
IG Corporates
A Corporates
AA Corporates
Total Return Excess Return Source: Bloomberg Barclays U.S. Intermediate IG Corporate Index, as of September 30, 2017.
t
17
7
7
-1
Se p-
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7
ay -1 M
7
ar -1 M
-1 Ja n
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16
ov N
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6 -1 Ju l
6 ay -1 M
ar -1 M
-1 6 Ja n
0.2%
6
50
0.4%
t
AA Corporate Index A Corporate Index BBB Corporate Index Source: Bloomberg Barclays U.S. Intermediate IG Corporate Index, as of September 30, 2017. t
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Q3 2017 CORPORATE BOND COMMENTARY MARKET TECHNICALS: SUPPLY & DEMAND Supply Up but Mergers Down in 3Q17
Figure 9: Domestic and Foreign Fund Flows into the U.S. FigureMarket 9: Domestic and Foreign Fund into the Corporate Bond Have Picked upFlows in 2017 U.S. Corporate Bond Market Have Picked up in 2017
500
IG corporate bond issuance of $377 billion in 3Q17 increased by 2 percent year-over-year. Low interest rates and tight spreads continue to encourage high borrowing. IG new issuance is over $1 trillion year-to-date, the sixth year in a row that issuance has topped that figure. U.S. merger volume of $287 billion in 3Q17 decreased by 25 percent year-over-year reflecting a combination of elevated valuation multiples and uncertain U.S. tax policies. Figure 8: Low Rates Have Sustained High Borrowing, While Figure 8: Low on Rates HaveValuations Sustained High Borrowing, Mergers have Slowed High While Mergers have Slowed on High Valuations
1400 1200
$Billions
1000 800 600 400 200 0 YTD-16
t
YTD-17
3Q16
3Q17
U.S. IG Corporate Issuance U.S. Mergers & Acquisitions* Source: Bloomberg, as of September 30, 2017. * Dollar value includes pending and completed U.S. mergers & acquisitions.
Strong Demand from Domestic and Foreign Investors Solid fund flows have continued, with IG bond mutual funds reporting LTM inflows of $110 billion. Purchases of U.S. corporate and foreign bonds by foreign residents have also been notably strong. Foreign flows have increased, with IG corporate purchases estimated at over $400 billion for the LTM period.
$Billions
400 300 200 100 0 2015 t
2016
LTM 2017
Domestic Long-Term IG Bond Mutual Fund Flows Net Purchases of U.S. Corporate Bond Issues by Foreign Residents Source: ICI, as of September 30, 2017 and Federal Reserve Flow of Funds, as of 2Q17.
BRECKINRIDGE STRATEGY Overweight High-Quality Corporates Credit fundamentals remain mixed, with gross leverage at a record high for IG companies while the forward profit outlook has seemingly improved on more solid economic growth and potential tax reform. A reduction in the U.S. corporate tax rate could especially benefit domestic-oriented firms, and a potential tax-advantaged repatriation of overseas cash could improve multinationals’ liquidity and reduce debt issuance— depending on how proceeds are deployed. Still-elevated share buybacks and weak capex growth are indicative of a shorterterm focus by some management teams, and we continue to closely monitor environmental, social and governance (ESG) risks. Given valuations, we are targeting an overweight to AA and A-rated corporates and an underweight to BBB corporates within the context of an overweight corporate allocation in our government credit strategies. Within the corporate sector allocation, we are overweight the Banking, Pharmaceuticals and Technology sectors. We are underweight Basic Industry and REITs bond issuers. We maintain a modest barbell strategy and are duration neutral in government/credit strategies relative to their benchmarks. t
DISCLAIMER: This material has been prepared for our clients and other interested parties and contains the opinions of Breckinridge Capital Advisors, Inc. Information and opinions are current as of the date(s) indicated and are subject to change without notice. Any specific securities or portfolio characteristics are for illustrative purposes and example only. They may not reflect historical, current or future investments in any client portfolio. Nothing in this document should be construed or relied upon as tax, legal or financial advice. All investments involve risk – including loss of principal. An investor should consult with an investment professional before making any investment decisions. Breckinridge can make no assurances, warranties or representations that any strategies described will meet their investment objectives or incur any profits.This document may include projections or other forward-looking statements, which are based on Breckinridge’s research, analysis, and assumptions. There can be no assurances that such projections will occur and the actual results may differ materially. Other events that were not taken into account in formulating such projections may occur and may significantly affect the returns or performance of any account. Past performance is not indicative of future results. This document includes information from companies not affiliated with Breckinridge (“third party content”). Breckinridge reasonably believes the third party content is reliable but cannot guarantee its accuracy or completeness.
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