- USD corporate bonds staged a significant market recovery from their March 2020 lows and delivered equity-like returns despite increased debt issuance and uncertainty in both fundamentals and the economic environment.
- High dispersion in factors and sectors offered opportunities for active managers. Within investment grade, defensive factors outperformed in Q1 and procyclical factors in Q2. Health care and IT led sectors, while energy lagged.
- Sustainable investing in corporate bonds showed defensive characteristics and helped mitigate drawdowns in both the investment-grade and high-yield universes.
In the short term, the COVID-19 crisis had a profound impact on how companies have had to manage cash flows and liquidity in a time when business operations remained highly uncertain. Corporate issuers raised new debt at an accelerated pace to secure cash following the Federal Reserve’s announced plan to purchase ETFs linked to corporate bonds and individual securities. With the notable increase in issuance, investors in corporate bonds now face the possibility of increased leverage, credit-rating downgrades and default risks, should economic conditions deteriorate.
Investment-Grade Bonds Recovered Faster Than High-Yield Bonds
In the second quarter, investors in USD corporate bonds experienced equity-like returns. The MSCI USD Investment Grade (IG) Corporate Bond Index returned 8.4% (after having fallen 2.5% in Q1), and the MSCI USD High Yield (HY) Corporate Bond Index returned 12.1% (after a 14% drop in Q1), largely from the compression in credit spreads.
IG Was Positive, and HY Negative, in the Year to Date
Cumulative performance of MSCI’s USD IG and HY corporate-bond indexes over the first half of 2020. The vertical line marks the time before the Fed’s March 23 announcement of the U.S. economic-stimulus package.
A Tug of War Between Defensive and Procyclical Credit Factors
Defensive factors, characterized by bonds with shorter durations (as represented by the MSCI USD IG Low Risk Corporate Bond Index) and stronger fundamentals (MSCI USD IG Quality Corporate Bond Index), fared better during the market downturn in Q1 2020 — perhaps due to investors’ confidence in these issuers’ ability to withstand supply and demand disruptions during the initial widespread lockdowns. Procyclical factors like carry (MSCI USD IG Carry Corporate Bond Index), low size (MSCI USD IG Size Corporate Bond Index) and value (MSCI USD IG Value Corporate Bond Index) outperformed during the market recovery in the second quarter.
Q1 Versus Q2: A Shift from Defensive to Procyclical Factors
Active total returns and active excess returns across MSCI USD IG corporate-bond factor-tilt indexes versus the MSCI USD IG Corporate Bond Index in Q1 and Q2 2020.
High Sector Dispersion Offered Opportunities for Active Managers
To see how corporate bonds performed across sectors, we plotted the total returns of the MSCI USD IG and HY Corporate Bond Indexes relative to their respective parent indexes, based on the underlying issuer’s Global Industry Classification Standard (GICS®)1 sector. The energy sector suffered the most during the first half of the year, in both the IG and HY universes, due to low oil demand and the subsequent collapse in oil prices as COVID-19 spread. Over the first half of the year, information technology and health care emerged as the best-performing sectors, in both IG and HY.
IT and Health Care Led and Energy Lagged in the First Half of 2020
Active total returns across GICS sectors within the MSCI USD IG and HY Corporate Bond Index universes in H1 2020.
The performance dispersion among sectors offered opportunities for top-down active managers of corporate bonds.
ESG Tilts Helped Mitigate Drawdown in Corporate Bonds
In the exhibit below, we plotted the weighted average ESG scores of the various ESG-tilted corporate-bond indexes along with their respective parent indexes, as of June 30, 2020.2
ESG Scores Varied by Credit Quality and Index Construction
We observed:
- The ESG scores for best-in-class ESG indexes, such as the MSCI ESG Leaders Indexes and Bloomberg Barclays MSCI Corporate Sustainability Indexes, were higher than for the reweighted ESG indexes.
- The MSCI investment-grade ESG indexes had notably higher ESG scores than the MSCI high-yield ESG indexes — which indicated a positive correlation between credit ratings and ESG ratings.
The various ESG indexes showed resilience to the broader corporate-bond market’s drawdown (vis-à-vis their respective parent indexes) during the COVID-19 crisis in the first quarter. The exhibits below show the short-term (Q1 and Q2 2020) and long-term (YTD 2020 and one-, two- and five-year) performance of ESG indexes.
ESG Indexes Exhibited Defensive Characteristics
Active total returns across MSCI USD IG and HY corporate-bond ESG indexes and Bloomberg Barclays MSCI US Corporate Bond ESG Indexes with respect to their benchmarks in Q1 and Q2 2020.
Long-Term Performance of Corporate-Bond ESG Indexes
| MSCI USD IG Corporate Bond Index’s Total Returns | |||||
|---|---|---|---|---|---|
| YTD 2020 | 1-Year | 2-Year | 5-Year | ||
| Parent Index | USD IG Corp Bond | 5.7% | 10.1% | 22.0% | 32.0% |
| ESG Indexes | ESG Leaders | 6.0% | 10.3% | 22.2% | 32.1% |
| ESG Universal | 6.0% | 10.4% | 22.2% | 32.2% | |
| MSCI USD HY Corporate Bond Index’s Total Returns | |||||
|---|---|---|---|---|---|
| YTD 2020 | 1-Year | 2-Year | From Sep 2016* |
||
| Parent Index | USD HY Corp Bond | -3.5% | 0.0% | 6.9% | 15.1% |
| ESG Indexes | ESG Leaders | -3.6% | -0.5% | 6.1% | 12.5% |
| ESG Universal | -3.4% | 0.0% | 7.1% | 14.0% | |
| Bloomberg Barclays MSCI US Corporate Bond IG Index’s Total Returns | |||||
|---|---|---|---|---|---|
| YTD 2020 | 1-Year | 2-Year | 5-Year | ||
| Parent Index | US Corp IG | 5.0% | 9.5% | 21.2% | 32.7% |
| ESG Indexes | Sustainability | 5.7% | 10.1% | 21.7% | 32.7% |
| ESG-Weighted | 5.6% | 10.0% | 22.0% | 33.2% | |
All returns as of June 30, 2020. *MSCI HY ESG Index levels are calculated starting Aug. 31, 2016.
Taking Credit on the Lessons Learned
In the first half of 2020, there were some key lessons learned from a corporate-bond investor’s perspective. The heightened levels of market volatility offered new opportunities to active managers, as we witnessed strong dispersion in factor and sector performance. The market turmoil also represented a real stress test for fixed-income sustainability, and ESG tilts in indexes helped mitigate market drawdowns. Overall, looking at corporate bonds through the lens of factors and ESG characteristics provided a fresh look at fixed-income markets.
1GICS is the global industry classification standard jointly developed by MSCI and Standard & Poor’s.
2The MSCI USD Corporate Bond ESG Indexes and the Bloomberg Barclays MSCI ESG Fixed Income Indexes are designed to have higher exposures to issuers with higher environmental, social and governance (ESG) ratings relative to the parent index. This ESG tilt is achieved either through reweighting the parent index using ESG criteria (as with the MSCI ESG Universal Indexes and MSCI ESG-weighted indexes) or through a best-in-class approach — i.e., ranking and selecting issuers with the strongest ESG profile (the MSCI ESG Leaders Indexes and Bloomberg Barclays MSCI Corporate Sustainability Indexes).
Further Reading
Surging Corporate-Bond Supply: Reason to Worry?
Factors and corporate bonds: Single- and multi-factor approaches to corporate credit