Corporate Bonds Are Hot & They Could Get Hotter

Corporate bonds have shown strong performance this year, but their elevated valuations, with spreads near 1990s lows, are a concern. Despite this, some experts anticipate continued upside, especially for actively managed ETFs like the Neuberger Berman Flexible Credit Income ETF (NBFC), which can adapt to market shifts. This outlook is driven by perceived issuer strength, potential valuation adjustments following a government shutdown, and a growing view that investment-grade corporate bonds offer safety comparable to or better than Treasuries, prompting some to use alternative benchmarks like interest-rate swaps.

Analysis

Corporate bonds, spanning both investment-grade and high-yield segments, have delivered strong performance year-to-date, positioning them as a leading fixed income asset class. This robust rally has compressed the spread between blue-chip corporate debt and US Treasuries to approximately 0.73 percentage points, a level reminiscent of the 1990s, prompting investor concerns regarding potential overvaluation. However, the overall sentiment remains optimistic, with a strongly positive score of 0.65.

Despite these elevated valuations, some experts foresee continued upside, particularly for actively managed funds like the Neuberger Berman Flexible Credit Income ETF (NBFC), which holds a positive sentiment score of 0.75. Active management provides the flexibility to adjust portfolios and exploit valuation opportunities, a key advantage over passive corporate debt ETFs in the current market. This adaptability is crucial given the perceived frothiness.

The underlying drivers for this optimism include issuer confidence in their ability to service outstanding obligations, as implied by current valuations, and the potential for valuation adjustments once the ongoing government shutdown resolves. Furthermore, investment-grade corporate bonds, a component of NBFC's portfolio, are increasingly viewed by some market participants as offering safety comparable or superior to Treasuries. JPMorgan Chase & Co. notes that some investors are now utilizing interest-rate swaps as a reference rate, questioning Treasuries' traditional benchmark status due to perceived political and government factors.

Key Decisions for Investors

• Investors should consider actively managed corporate bond ETFs, such as NBFC, for their potential to navigate current valuation challenges and capitalize on market opportunities through dynamic portfolio adjustments.
• Monitor developments regarding the government shutdown, as its resolution could lead to valuation adjustments in corporate bonds, potentially creating strategic entry or exit points.
• Re-evaluate the traditional role of Treasuries as a safety benchmark, acknowledging the growing perception of investment-grade corporate bonds as comparable alternatives and the increasing adoption of interest-rate swaps as a reference rate.