All-time wide yield ratios create compelling credit opportunities

Executive Summary:

  • Divergence of higher credit spreads with lower Treasury yields creates a rare opportunity. 
  • Historically, this has represented a compelling entry point for long-term investments in credit sectors. 
  • With PGIM Investments you can choose from a variety of strategies which may benefit from this dislocation.

Market volatility has led to Treasury yields declining to record lows and rising credit spreads. The result is the ratio of credit yields to the 10-year Treasury soaring to historic highs. After previous episodes where spreads significantly widened, credit sectors provided strong returns in the subsequent 12-months.

Divergence of higher credit spreads with lower treasury yields creates rare opportunity

  • As investors sought safety, Treasury yields fell sharply while credit spreads significantly widened. 
  • Historically, this has represented a compelling entry point for investments in credit sectors based on subsequent 12-month returns following yield ratio widening periods.

Yield ratios are at all-time highs

Recent yield ratios for various credit sectors have been higher than during previous spread widening periods, such as those seen during the 2008 Global Financial Crisis, 2012 European Debt Crisis, and 2016 Oil Price Collapse.

Historically strong returns after significant yield ratio widening periods

  • Historically, periods with above-average yield ratios such as those seen during the Global Financial Crisis, European Debt Crisis, and Oil Price Collapse have been short lived, with credit sectors providing strong returns in 12 months after those significantly wide spread periods.

Higher income from credit sectors

  • Credit sectors currently offer significantly higher yields at multiples of 4 to 13x higher than the 10-year Treasury rate of 0.93%.

Source: PGIM, PGIM Fixed Income as of 31/12/19. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Assets under management (AUM) are based oncompany estimates and are subject to change. PGIM Fixed Income’s AUM includes the following businesses: (i) the PGIM Fixed income unit within PGIM, Inc, located in the USA; (ii) the public fixed income unit within PGIM Limited, located in London; (iii) PGIM Netherlands B.V. located in Amsterdam; (iv) locally managed assets of PGIM Japan Co., Ltd. (“PGIM Japan”), located in Tokyo; and (v) the public fixed income unit within PGIM (Singapore) Pte. Ltd., located in Singapore. Asset class breakdown based on company estimates and is subject to change. 1 Other includes Japanese equities and Japanese real estate equities.

Definitions and Indices—Credit Spreads are the difference in yield between a treasury and a non-treasury security which are identical outside of credit rating. Option Adjusted Spread (OAS) is the difference between a bond’s yield and the rate of return for a similar maturity, risk-free security after adjusting for options. Yield to worst (YTW) is a measure of the lowest possible yield that can be received on a bond that fully operates within the terms of its contract without defaulting. The 10-year Treasury is a debt obligation issued by the United States government with a maturity of 10 years upon initial issuance. The 10-year yield is used as a proxy for mortgage rates and other measures; it's also seen as a sign of investor sentiment about the economy. The Bloomberg Barclays U.S. Credit Index measures the investment grade, US dollar denominated, fixed-rate, taxable corporate and government related bond markets. It is composed of the US Corporate Index and a non-corporate component that includes foreign agencies, sovereigns, supranationals and local authorities. The Bloomberg Barclays Emerging Markets USD Aggregate Index is a flagship hard currency Emerging Markets debt benchmark that includes fixed and floating-rate US dollar-denominated debt issued from sovereign, quasi-sovereign, and corporate EM issuers. The Bloomberg Barclays U.S. Universal Index (ex Treasuries and Agencies) measures the performance of U.S. dollar-denominated taxable bonds that are rated either investment-grade or high yield. Bloomberg Barclays U.S. Corporate High Yield Index covers the USD-denominated, non-investment grade, fixed rate, taxable corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below. A small number of unrated bonds are included in the index. The index excludes emerging markets debt. The J.P. Morgan Leveraged Loan Index is designed to mirror the investable universe of U.S. dollar institutional leveraged loans, including U.S. and international borrowers. All indexes are unmanaged. Investors cannot invest directly in an index.

Notice

For Professional Investors only. All investments involve risk, including the possible loss of capital.

PGIM Fixed Income operates primarily through PGIM, Inc., a registered investment adviser under the U.S. Investment Advisers Act of 1940, as amended, and a Prudential Financial, Inc. (“PFI”) company. PGIM Fixed Income is headquartered in Newark, New Jersey and also includes the following businesses globally: (i) the public fixed income unit within PGIM Limited, located in London; (ii) PGIM Japan Co., Ltd. (“PGIM Japan”), located in Tokyo; (iii) the public fixed income unit within PGIM (Singapore) Pte. Ltd., located in Singapore (“PGIM Singapore”); and (iv) PGIM Netherlands B.V., located in Amsterdam (“PGIM Netherlands”).PFI of the United States is not affiliated in any manner with Prudential plc, incorporated in the United Kingdom or with Prudential Assurance Company, a subsidiary of M&G plc, incorporated in the United Kingdom. Prudential, PGIM, their respective logos and the Rock symbol are service marks of PFI and its related entities, registered in many jurisdictions worldwide.

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This article represents the views, opinions and recommendations of the authors as of 20/3/2020 regarding the economic conditions, asset classes, securities, issuers or financial instruments referenced herein. It is not intended as an offer or solicitation with respect to the purchase or sale of any security or other financial instrument or any investment management services and should not be used as the basis for any investment decision. No liability whatsoever is accepted for any loss (whether direct, indirect, or consequential) that may arise from any use of the information contained in or derived from this article.

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