Top-Quality Corporate Bonds Rally as a Preferred 'Safe Haven'

07/31/2012| 11:57am US/Eastern

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   By Patrick McGee 
 

Investment returns on highly rated corporate bonds are outpacing their lower-rated peers this month as investors look for safe-haven alternatives to Treasurys.

Bank of America Merill Lynch Research notes that spreads on AA-rated bonds declined by 25% in July, versus 13% for A-rated and 8% for BBB-rated debt. Spreads measure the extra yield premium these corporate bonds pay investors, compared with yields on comparable Treasury securities. Since bond yields move inversely to prices, the bigger decline for top-rated bonds indicates robust demand for safer forms of debt.

The researchers suggest sovereign wealth funds and other high-quality bond investors are being "forced to invest in corporate bonds" because Treasurys yield too little. As a result, top-rated corporate bonds are starting to look too expensive, while BBB-rated industrials "now contain the most value."

Companies have responded to broadened demand by issuing more corporate bonds this month than any other July on record, according to Dealogic, whose records go back to 1995. The data provider counts $65 billion of issuance from investment-grade companies this month through Monday, easily beating the $57.4 billion July record from 2010.

The onslaught is continuing Tuesday with new deals from Citigroup Inc. (C), Ford Motor Credit, Ventas Inc. (>> Ventas, Inc.), PPG Industries Inc. (>> PPG Industries, Inc.) and Korea Finance Corp.

Moreover, non-financial corporate issuance is running at an all-time high year-to-date: $386.2 billion--35% more than the same period last year. Financial issuance, by contrast, is down 23% from last year, to $204.3 billion.

Total corporate issuance is at $578 billion, ranking as the second-highest on record after 2009, which at the end of July stood at $669 billion.

The five issues so far Tuesday follow a blazing Monday, when roughly $10 billion hit the market as interest rates remain at record lows. The average yield in Barclays's high-grade corporate index is 2.96%, the lowest in nearly four decades of data.

Despite the lower and lower yields, buyers remain enticed given how well high-grade bonds continue to perform. The year-to-date total return is 7.5%, per Barclays. In July alone, high-grade bonds paid investors 2.73%, making it the best month since June 2009.

Write to Patrick McGee at patrick.mcgee@dowjones.com

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