The Federal Reserve’s purchase of corporate bonds–the most radical measure it took to rescue the financial markets from their near meltdown four months ago–has had a far more profound impact than the numbers would suggest.
While the central bank’s balance sheet has exploded by 50%, to $7 trillion, since it announced its aggressive steps, it had added just $44 billion in corporate debt as of Wednesday. It didn’t have to purchase more because its actions set off a stampede of corporate bond buying by investors, allowing companies to issue more than $1 trillion in debt in the first half, smashing the full-year record set in 2017.
That’s great for companies seeking to add liquidity to their balance sheets and to refinance outstanding debt at historically low interest costs. But investors seeking attractive yields from quality securities are largely out of luck. Among them is Dan Fuss, the veteran manager of the Loomis Sayles Bond fund (ticker: LSBRX), whose forte during his six decades in the market has been finding bargains among corporate bonds, especially in times of duress, when others are being forced to liquidate securities. With nobody feeling fearful because of the Fed’s presence, Fuss doesn’t have much chance to be greedy, to quote the maxim from
(BRK.B) Warren Buffett.
Given bonds’ low absolute yields, “you are not really getting compensated for credit risk, in my opinion,” Fuss says in a telephone interview. Spreads—the extra yield to compensate for the risk of holding a corporate security over a risk-free Treasury issue—“look okay.” But with Treasuries’ yields near record lows —0.59% for the benchmark 10-year note and 1.25% for the 30-year bond—corporate bonds are still producing too little return.
That’s even true in the high-yield market, which the Fed indirectly influences. A company that had an investment-grade credit rating as of March 22, the day before the central bank established its corporate-bond purchase facilities, qualifies for the program.
(F) became one such “fallen angel” after Standard & Poor’s cut its rating to BB+ on March 23, pushing the auto maker’s $35.8 billion in outstanding debt below investment-grade.
The Fed’s purchases effectively have lowered all corporate bond yields, including those on new, smaller issues priced off outstanding securities, Fuss continues. To deal with the paucity of attractive yields, he’s taken a two-pronged approach.
First, he’s gotten “very persnickety” about credit quality, with the highest credit ratings for the Loomis Sayles fund averaging around A-, and owning a lot of Treasuries. Second, he’s buying high-yielding stocks as a substitute for low-yielding corporate bonds, to the extent permitted by the strictures on the portfolios he manages.
Without naming names, Fuss says he’s a value-stock buyer with a strong bent for safety, as would be expected for a bond investor. He favors companies with strong financials, good market positions, relatively generous dividend yields, and a good record for raising payouts. “You have to be careful earnings will be there to support the dividend and buybacks, even if the corporate tax rate rises next year if there is a change in administration and the Congress,” he adds.
A year ago, Fuss told me he was taking this tack with the common shares of
(T). That stock, which remains a holding, is an extreme example, as it yields almost 7%, about twice what the telecom’s long-term bonds do. However, the shares slumped Thursday, even though the company reported better-than-expected earnings.
So, not even a master investor like Fuss has escaped the conundrum presented by the Fed’s extraordinary monetary policy: accept historically low yields on investment-grade bonds or accept higher risks to earn an acceptable return. His solution is to eschew risk in bonds and instead take it in equities, albeit the stolid, high-yielding shares largely left behind in a market dominated by mega-cap growth names. That is another game entirely.
Write to Randall W. Forsyth at firstname.lastname@example.org