Investment-grade bond managers are labeling 2021 and 2022 as the years of the upgrade, with a bonanza of high-yield companies set to climb up the credit scale.
In anticipation of ratings agencies upgrading up to $100 billion in high-yield companies' bonds to investment-grade status this year, with a further up to $200 billion earmarked for upgrades in 2022, investment-grade managers — where strategies allow — are adding junk bonds that they expect to be upgraded in hopes they will reap the benefits.
"2021 will be the year of the upgrade," said Matt Brill, Atlanta-based head of North America investment-grade and senior portfolio manager at Invesco Ltd.'s fixed-income business. "The main takeaway is that the momentum is positive for corporate deleveraging. ... That's gone through the pendulum swing very far down to the downgrade side (when) institutions were deteriorating in terms of credit quality last year," and now the opposite is true, he said. The firm had $296.4 billion in fixed-income assets under management as of Dec. 31.
Vontobel Asset Management AG's fixed-income team expects $200 billion to $300 billion of U.S.-based high-yield debt to be upgraded to investment-grade status by the end of next year, with about €50 billion ($59.6 billion) for Europe over the same period.
A Dec. 2 paper by S&P Global Ratings said an estimated $367.2 billion in outstanding debt had been downgraded from investment-grade status so far in 2020. The paper covered the U.S. and Europe, Middle East and Africa.
"It's tough to get a precise answer (of how much will be upgraded) but the topic is gaining traction because we entered a new period in the credit cycle with COVID-19," said Christian Hantel, Zurich-based senior portfolio manager.
"It was a disaster last year because EBITDA was falling off a cliff ... credit numbers deteriorated sharply," and the result was some companies were downgraded, he said.
But as the global economy is moving into the recovery period, it is "all about healing and repairing balance sheets and restoring credit metrics," with signs already pointing in that direction, Mr. Hantel said, citing fourth-quarter earnings coming in "quite solidly across the globe." Vontobel ran 48 billion Swiss francs ($54.4 billion) in fixed-income assets under management as of Dec. 31, according to its 2020 annual results.
Companies such as Kraft Heinz Co. are credits in which investors are taking positions in anticipation of upgrades this year or next, sources said.
And though there are no specific sectors from which managers expect upgrades to originate, Mr. Brill described three "buckets" of companies that are on the potential upgrade list: fallen angels, which were downgraded to junk status in 2020 but are expected to return this year or next; companies that have languished in the high-yield category for years, such as some of the homebuilders downgraded in the aftermath of the global financial crisis that have benefited from delevering and a better housing market; and newer companies such as technology firms that have not yet built up mature credit structures to be admitted to investment-grade.
In that final set of firms, managers named companies such as Netflix Inc. among candidates for an upgrade.