UBS is bullish on investment-grade corporate bonds. Here’s why

Yields may be down from last year’s highs, but there is still plenty for income investors to like about investment-grade corporate bonds, according to UBS. The effective yield on the ICE BofA U.S. Corporate Bond Index , which tracks the performance of U.S. dollar-denominated investment-grade corporate debt, is currently hovering around 5.5%. Last October, it was 6.4%. Bond yields move inversely to prices. The total return on investment-grade (IG) bonds has faced headwinds from the interest rate component as Treasury yields moved higher since the beginning of the year, Barry McAlinden, a fixed income strategist in UBS’s chief investment office, wrote in a late March note. The 10-year Treasury currently yields about 4.36%. “IG’s excess return has been a different story,” he said, noting that it is up 1.1% year to date, as of March 22. “This measures IG’s return over duration-matched Treasuries, meaning that it’s been advantageous to own IG over U.S. government bonds,” he added. One reason for the excess return is the strong primary market issuance in investment grade debt, which has contributed to its average market-weighted coupon increasing to 4.2% from 3.65% in 2022, McAlinden said. “This equates to an income return for IG of about 35bps per month, compared to 22bps for Treasur[ys], with a market weighted coupon of 2.7%,” he said, referring to basis points, or one one-hundredth of a percentage point (0.01%). Spreads over Treasurys are also likely to stay resilient, McAlinden believes. “Receding inflation, moderating growth, and sound corporate profits should keep IG investor demand strong and issue fundamentals in check,” he said. Inside the investment grade market, UBS prefers the financial sector over non-financial issuers, and favors short- and intermediate-term duration. “The short end (1-3 year) provides low-volatility carry while longer duration (7-10 year) should perform well from a total return standpoint” thanks to a view that nominal yields will be lower by year end, McAlinden said. Meanwhile, the spread pickup from A-rated bonds to BBB-rated bonds are historically tight, on average. But the strategist has a benign view on credit fundamentals, and is therefore neutral on As versus BBBs. Bonds that are rated BBB- or higher at Standard & Poor’s and Fitch, and Baa3 or higher at Moody’s, are considered investment grade.