Over 1300 EMEA Investment Grade credit bonds will redeem in 2018, returning in excess of $1trillion worth of investors' capital[1] into already buoyant markets, according to predictions from MUFG.
MUFG, the world's fifth largest bank, highlights the dilemma that many investors could face next year as they seek to generate returns in a low-rate, low-return environment.
A key driver behind the wave of fixed income credit that will redeem in the years 2018-2023 in particular, was the high return provided to the market by borrowers in the aftermath of the financial crisis. Borrowers compensating for the economic uncertainties of that period led to coupon levels for investment grade debt in excess of 5%, as they sought to diversify away from bank debt and seek long-term capital from the public bond markets.
The investment grade credit markets, fuelled by global QE, have provided investors with the platform of safe-haven investment at positive returns, while also providing borrowers with significant term capital capacity at attractive levels, according to MUFG. This has resulted in a shift in mind-set from bank-first to bond-first term financing in recent years.
MUFG believes fixed income investors will find it increasingly challenging to deploy capital and generate comparable returns to prior years without a continued rebalancing of risk appetite – however, with traditionally higher risk/return asset classes already having rallied to record low levels, such a strategy is not without its challenges.
Anthony Barklam, Co-Head, Debt Capital Markets – Bonds & Loans, at MUFG, says:
"While the bond market has significant amounts of capital redeeming each year, the current buoyancy of both equity and credit markets, together with a likely change in direction for global rates and quantitative easing, suggests that borrowers in 2018 should be prepared for an investor base that doesn't necessarily perceive the market as a one-way bet any more.
"However, that said, where corporate borrowers want to roll-over their debt, commercial banks are now in a much stronger position, with far greater liquidity, than at any time over the past decade. This is creating tougher competition between the bond and bank market and issuers may opt for the latter if institutional investors start changing their current tune and market conditions change."
The majority of the bonds that will redeem in 2018 are from financial institution issuers, which make up $600bn worth. This is followed by corporate issuers with $300b worth, and major emerging market issuers of $200bn [2].
Barklam continues:
“Many asset classes – equities, property and commodities, not to mention bitcoin – have experienced substantial in-flows and valuations continue to skyrocket. With the market this frothy, investors should be concerned, and rightfully so, about where they will reinvest the $1tn of returned cash in 2018. Finding pockets of value will be increasingly challenging.
"If credit spreads and investment returns continue to shrink, pensions funds, insurers and other holders of long-term, patient capital may elect to put a greater amount of cash under the mattress until value returns, rather than invest simply to stay invested."
[1] (excluding Western European Sovereign and supranational)
[2] Data provided by Dealogic.