What Next for Corporate Bonds?

Morningstar's Louise Babin talks to M&G's Richard Woolnough about the bond market and why credit quality in corporate bonds has declined as the market has expanded

Louise Babin 7 May, 2019 | 12:01AM
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Louise Babin: Hello. From the Morningstar Investment Conference in London. I'm Louise Babin and I have with me today M&G’s Richard Woolnough to talk about fixed income.

Hi, Richard.

Richard Woolnough: Good morning.

Babin: So, you were talking earlier on in your presentation about the corporate bond market and the fact that externally it looks like it has grown quite rapidly and deteriorated a lot in the credit quality. It sounds like this didn't concern you, but could you elaborate on that for us?

Woolnough: Yes, quite interesting. If you think about a marketplace when it first starts, it's going to be limited in its size. By definition, the start is going to be small. And secondly, in terms of sophistication and debt for liquidity. So, we look up at bond markets when it first started in sort of Europe and Sterling, it was a higher quality companies that came because there wasn't the infrastructure to understand and follow them. But as time goes by companies with that as much security when the borrower come to the fore new companies that you wouldn't have been able to lend before come to the fore, and you get the portfolio of risk. So, sort of the larger market begets larger market, and so over time you're going to expect corporate bond market to accelerate in its size, which it has done in UK, US and Europe and you'd expect to over time to be open to more players, not only from an investment perspective but from a borrower perspective.

So, basically what's happened over the last turn of time last 20, 30 years is bring this huge development in an alternative way for companies to fund themselves besides bank lending, besides equity they do for the corporate bond market and that's allowed a huge variety of international issuers, sectors and credit quality to come to the marketplace which makes it far more dynamic interesting place to invest than just what it was 20 years ago.

Babin: And the kind of lower credit quality on average that we're seeing doesn't really concern you too much because you're not that worried about recession, your expectations are for no recession. Just wondered what you're monitoring or signals you're looking at to just make sure that that doesn't turn?

Woolnough: Yeah, we look at Main Street as opposed to Wall Street. It's quite common for people to look at Wall Street as the main indicator of where it can go. The stock market is down, recession is around the corner. I think that can send you too many false signals and predict too many recessions that we're seeing of late. So, we look at things that drive the economy where interest rates are heading, what the unemployment rates going to be how is the housing market behaving and strange enough where the oil price is. The oil price has been a big driver of the economic cycles in the past, particularly in the '70s when I was growing up. And so we look at all those for to try to work out how much brakes have been put on the economy and how much headwinds on the economy and we use that to look at where we are.

At the moment, the oil prices had a rally recently, it was unchanged year-on-year, the housing markets are generally okay in the developed markets. We're near full employment and the fact that there is no sign of unemployment slowing down. So, it's really, really hard to see why recession is around the corner. And from my opinion the banks are still – the Central Banks are still pursuing a very dovish policy. The U.K. stands very low rates, Europe still has negative rates and it takes two years for interest rate policy to work. So if it takes two years for interest rate policy to work and we have no big increase in U.K. rates or European rates then it's very hard to see how we get recession in the next two years.

Babin: Interesting. Well, thank you, Richard. And from the conference, thank you very much for watching.

This article is part of Morningstar's special report on What the Experts Say

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Louise Babin  is a senior analyst for Morningstar.

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