Institutional investors are staring down potential massive downgrades in their investment-grade corporate bond portfolios that could force selling at losses and cause further damage to portfolio returns.
As the coronavirus lockdown continues to impact corporations' bottom lines on both sides of the pond, about $215 billion U.S. and €100 billion ($108 billion) European investment-grade debt is expected to be downgraded to high yield this year, according to J.P. Morgan Ltd.'s research published March 23.
Despite the Federal Reserve's support for bond prices announced March 23 and extended April 9, investors could still see fundamental losses, sources said. The Fed, through a secondary purchase program, could scoop up to $250 billion worth of investment-grade bonds including those downgraded to junk — known as fallen angels — as well as exchange-traded funds that track U.S. investment-grade corpo- rate bonds and U.S. high-yield bonds. And when more index providers reconfigure investment-grade bond benchmarks at the end of April, additional investment-grade investors could become forced sellers of bonds that may no longer fit the rules of their portfolios.
"The Fed's announcement is helping. But even if the spreads on investment-grade and high-yield corporate bonds will be controlled by the Fed's purchases and guarantees, the credit quality will deteriorate for investment-grade and high-yield companies," said Olivier Rousseau, executive director of the €33.6 billion Fonds de Reserve pour les Retraites, Paris, in a telephone interview.
Fallen angels are an issue as a large portion of companies with BBB- ratings have increased their leverage, he said, adding that a large proportion of these credits will move into the high-yield space.