- Despite a tumultuous year, multiple segments of the IG bond universe generated positive returns year-to-date.
- IG bonds continue to offer appealing yields despite rate cuts, supporting a stronger return potential, especially for longer-term investors.
- Yield pickup from high yield bonds are near extreme lows, reducing the incentive for investors to trade quality for higher yield.
- Fundamentals for IG issuers remain resilient despite high benchmark rates. We expect credit quality to remain healthy even if rate stay high in 2025.
- We believe it is still a good opportunity for investors to pocket high quality bonds at appealing yields despite tight spreads.
The year in summary
This year has been nothing short of a roller-coaster ride for global investment grade (“IG”) bonds. After weathering last year’s steep global rate hikes, the bond universe started the year on a soft footing. IG bond markets fell in 1Q as long-term sovereign yields surged relentlessly after markets walked back on their aggressive rate cut expectations, pricing fewer cuts in 2024.
IG bonds roared back to action in 2Q and 3Q as long-term UST yields dipped sharply, following soft US economic and inflation data. This afforded IG bonds some temporary reprieve as major indices rallied to hit year-to-date highs in 3Q. Meanwhile, credit spreads for corporate bonds have also started to compress meaningfully, which further contributed to returns.
Higher US treasury (“UST”) yield returned as a headwind for bond markets in 4Q, weighing on IG bonds despite support from credit spread tightening. Long-term sovereign yields first rose after the US election, led by US treasury (“UST”) yields, reflecting the potential inflationary uplift from the Trump administration’s policies. Long-term sovereign yields rose again after the Fed signaled for fewer cuts next year in December.
Despite a tumultuous year and gyrations in global treasury yields, multiple segments of the IG bond universe managed to generate positive returns year-to-date (Chart 1), marking another year of gradual recovery. As the global rate hike cycle comes to an end, we think IG bonds have found a firmer footing entering 2025 and have what it takes to stage a comeback. In this article, we share the reasons why we remain positive on IG bonds entering 2025 and why the segment remains an important part of investors’ portfolios.
Chart 1: Year-to-date performance of Global IG bonds
1. Appealing yields at near historical highs, despite rate cuts
Despite recent benchmark rate cuts across major central banks, yields for investment grade (“IG”) bonds remain attractive. In fact, yields remain close to their historical peaks, around the 90th percentile over the past 15 years, despite downward pressure from recent rate cuts. On an index level, global IG bonds (aggregation of sovereign, government-related, and corporate bonds) are offering a yield of 3.7%, much higher than the 15-year average of 2.1%.
IG corporate bonds offer a higher yield of around 4.7% (on an index level), as compared to the 15-year average of 3.2% (Chart 4). Higher yields for IG corporate bonds provide investors with a good pickup over treasury yields despite tight credit spreads. At the moment, the yield curves for IG corporate bonds are also steeper as compared to the respective treasury yield curves (Chart 2 and 3). This suggests that investors can find bond opportunities with much higher yields within the IG corporate universe, even at longer tenors – something we do not see for treasuries at the moment. Using USD IG corporate bonds as an example, investors can achieve over 5% yields with slightly longer tenor bonds as the corporate bond curve is much steeper than the US treasury curve.
Chart 2: The USD IG corporate bonds curve is much steeper than the US treasury curve…
Chart 3: …the same can be observed for the EUR IG corporate bonds curve
2. Higher yields point to stronger return potential
Bond yields can be a proxy for returns over a given time horizon. History shows that entering IG bonds when yields are higher has correlated with higher returns over the longer period (Chart 4), proving to be a good proxy for forward return. For the broad IG bond universe (aggregate of sovereign, government-related, and corporate bonds), entering with yields of between 3.0% - 4.0% (current index yield = 3.7%) has generated an index average cumulative return of 17.9% and 27.9% over the next three and five years respectively (annualised return of 5.6% and 5.0% respectively).
For IG corporate bonds, entering with yields between 4.0% - 5.0% (current index yield = 4.7%) have generated an index average cumulative return of 13.8% and 28.2% over the next three and five years respectively (annualised return of 4.3% and 5.1% respectively). Longer-term returns, especially over the three-year and five-year periods, have demonstrated a higher correlation to entry yields.
Today, higher-than-average yields offered by IG bond indices provide a good entry point, particularly for long-term investors. Not only can higher yields add predictability to returns, but by holding IG bonds longer, investors may achieve stronger returns while riding out near-term market volatility.
Chart 4: At an index level, higher entry yields have strongly correlated with higher 5-year forward returns for IG bonds…
Chart 5: …the same can be seen from corporate bonds
3. Lesser incentives to take on more credit risk
High quality bonds often trade at lower yields as credit spreads are narrower which reflects the difference in credit risks, assuming bonds of the same tenor. As a trade-off for higher quality, investors often have to settle for lower bond yields. On the contrary, investors have to climb down the quality ladder, taking on greater credit risk to achieve higher yields. However, in today’s environment, the ‘extra’ yields offered by HY bonds are much lower, making the trade-off between quality and yield unattractive.
At present, yields of lower quality bonds have fallen to a point where we see limited credit differentiation – higher yields from riskier bonds do not adequately compensate for the greater credit risk. Global high yield (“HY”) bonds currently offer a yield of 7.5% (on an index level), which is a mere 270bps pickup over global IG corporate bonds (Chart 6).
Over the past 15 years, HY bonds have provided an average yield pickup of around 372bps. This is much higher than what is observed today, which is near historical lows. In other words, there is now significantly lesser compensation for investors seeking to achieve higher yields through HY bonds on a market level. Particularly for risk-adverse investors, we think it makes more sense to stick with the quality income provided by IG bonds.
Chart 6: The yield pickup of global HY over IG corporate bonds is near historical lows.
4. Resilient fundamentals amidst high benchmark rates
Amidst the elevated benchmark rates and a higher cost of capital environment, credit fundamentals for IG issuers remain resilient. We believe fundamentals will remain healthy even if benchmark rates stay high, particularly as corporate earnings for IG issuers have stayed resilient while funding costs remain manageable. Based on our observation, funding costs for IG issuers have started to moderate after global benchmark rates were cut. The average coupon ( proxy for the issuer financing cost) for USD and EUR IG corporate bonds issued in 2024 has declined to 5.2% and 3.6% respectively, down from the 5.5% and 4.0% seen last year.
We also see little refinancing risk from IG issuers in the near term given current balance sheet strength, particularly as many non-financial IG issuers have fixed-rate debt with much longer-term maturity. While IG bonds tend to be more exposed to downgrade losses (fall in the value of a bond post-downgrade), we expect fallen angel risk (fall in IG to junk bond rating) to be low next year.
Table 1: The average coupon for USD and EUR IG corporate bonds issued in the first 11 months of 2024 has declined, suggesting lower funding costs.
Credit Rating | Average Coupon p.a. (%) | |||||
USD | EUR | |||||
Issued in 2023 | Issued in 2024 | Difference (bps) | Issued in 2023 | Issued in 2024 | Difference (bps) | |
AAA | 4.76 | 4.65 | -0.11 | 3.87 | 3.50 | -0.36 |
AA | 5.13 | 5.01 | -0.12 | 3.56 | 3.41 | -0.15 |
A | 5.47 | 5.06 | -0.41 | 4.03 | 3.42 | -0.61 |
BBB | 5.82 | 5.70 | -0.12 | 4.59 | 3.90 | -0.69 |
Average of all | 5.49 | 5.20 | -0.29 | 4.04 | 3.58 | -0.45 |
Source: Bloomberg, iFAST compilations. | ||||||
Pocket high quality bonds at appealing yields
Overall, we remain positive on IG bonds and believe it is still a good opportunity for investors to pocket high quality bonds at appealing yields despite tight spreads. Barring a global economic deterioration (which is not our base case), we see little factors pressuring IG credit spreads to widen significantly. We think credit spreads can hold, anchored by better issuer fundamentals, healthier credit metrics, and investor’s strong demand for yield.
From a portfolio perspective, IG bonds can provide good diversification potential for investors. Table 2 shows that IG bonds have recorded a low correlation against major equity indices over the past 15 years – even against the Straits Times Index. This is unlike HY bonds which have demonstrated equity-like correlations that are much higher in the same period. Low correlations suggest that IG bonds are suitable natural hedges against equities which can bolster diversification and ultimately reduce portfolio risk.
For investors looking for IG corporate bonds, table 3 highlights selected issuances that we like across USD and SGD space. These issuances can offer investors appealing yields in their respective markets.
Table 2: IG bonds demonstrated the low correlations against major equity indices, unlike HY bonds.
Correlations Over the Past 15 Years | ||||||||||
| MSCI World | MSCI EM | S&P 500 | STOXX 600 | Nikkei 225 | MSCI China | Straits Times Index | Global IG Agg. | Global IG Corp | Global HY |
MSCI World | 1.00 |
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MSCI EM | 0.76 | 1.00 |
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S&P 500 | 0.97 | 0.67 | 1.00 |
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STOXX 600 | 0.85 | 0.71 | 0.78 | 1.00 |
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Nikkei 225 | 0.68 | 0.59 | 0.61 | 0.65 | 1.00 |
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MSCI China | 0.53 | 0.85 | 0.46 | 0.50 | 0.48 | 1.00 |
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Straits Times Index | 0.66 | 0.73 | 0.59 | 0.64 | 0.62 | 0.58 | 1.00 |
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Global IG Agg. | 0.27 | 0.29 | 0.19 | 0.05 | -0.04 | 0.16 | 0.14 | 1.00 |
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Global IG Corp | 0.44 | 0.41 | 0.36 | 0.22 | 0.18 | 0.25 | 0.30 | 0.92 | 1.00 |
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Global HY | 0.76 | 0.68 | 0.69 | 0.60 | 0.49 | 0.45 | 0.60 | 0.54 | 0.74 | 1.00 |
Source: Bloomberg, iFAST compilations. Data as of 30 Dec 2024 (Weekly data since 30 Dec 2009) | ||||||||||
Table 3: Selected investment grade offerings across USD and SGD bond space.
Issues | Ask Price | Yield to Call/ Maturity | Years to Call/ Maturity | Bond Credit Rating (S&P/ Fitch) |
USD | ||||
97.56 | 5.51%/ 5.17% | 0.74/ 0.83 | BBB+/ BBB | |
97.99 | - / 5.31% | - / 2.14 | BBB-/ BBB+ | |
101.05 | - / 5.21% | - / 1.05 | BBB/ BBB | |
99.11 | - / 4.97% | - / 1.90 | BBB/ A- | |
SGD | ||||
108.40 | 4.23%/ 5.04% | 4.07/ 9.32 | BBB- (S&P)/ | |
102.65 | 4.04%/ 4.33% | 4.13/ 9.13 | BBB+/ A- | |
103.55 | 3.92%/ 4.20% | 4.70/ 9.71 | BBB/ A- | |
100.58 | - / 3.80% | - / 6.74 | BBB-/ N.R | |
101.62 | 3.65%/ 3.76% | 2.26/ 3.26 | BBB/ A- | |
Sources: Bondsupermart, iFAST Compilations. Data as of 27 December 2024. | ||||
Declaration:
For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) hold a position in MEITUA 2.125% 28Oct2025 Corp (USD), STANLN 4.300% 19Feb2027 Corp (USD), HYUELE 6.250% 17Jan2026 Corp (USD), HSBC 4.375% 23Nov2026 Corp (USD), CMZB 6.500% 24Apr2034 Corp (SGD), BNP 4.750% 15Feb2034 Corp (SGD), and the analyst who produced this report hold a NIL position in the abovementioned securities.
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