We believe there is a long shadow of the 2008 Global Financial Crisis (GFC) that still prejudices investor sentiment to risk and return within corporate bond markets.
Recently we were asked about default rates in investment grade credit, and what impact this had on our positive view of the asset class.
We answered that over time investment grade spreads more than compensate for the risks of generic ownership of investment grade bonds. To support our view we borrowed some long-term evidence from the 2016 S&P ratings analysis around defaults, covering the period from 1981 to 2016.
According to the study, the Lehman default was twice the size of the next largest defaulter – Ford Motor Co., in 2009 – which in turn was almost twice the size of Energy Future Holdings at $47bn in 2010. In each year prior to 2008 (excluding WorldCom in 2002), the total default amount was less than $10bn.
Yet the lingering concern for credit markets continues to be the revisiting of the scale and size of defaults in the GFC – and the knock-on contagion that curtails access to credit. Our brighter view is that there continues to be ready access to credit for investment grade issuers and that the outlook continues to be for solid, sustainable growth – which doesn’t have the same cyclicality as we have seen over the past 40 years (the period of the S&P study).
We would note that the 2008 GFC was the first systemic crisis within the S&P study period, while the next crisis is likely to take a very different format to that of 2008, not least due to the regulatory and macro prudential steps taken by authorities since 2009.
In the last five years, 99.7% of BBB issuers have not defaulted. In terms of the triple digit basis point spreads available in investment grade markets over that period (and today), the defaults have been almost de minimis. So we continue to believe that the ongoing benign economic outlook combined with active management can ensure good levels of capital preservation in well-constructed corporate bond funds.
2016 Annual U.S. Corporate Default Study And Rating Transitions – click here to view