Bond Watch: a longer-term risk that spells bad news for the bond market

Sam Benstead breaks down the latest news affecting bond investors.

Welcome to interactive investor’s ‘Bond Watch’ series, covering the latest market and economic news – as well as analysis – that is relevant to bond investors.

Our goal is to make the notoriously complicated world of bond investing simpler, by analysing the week’s most important news and distilling it into a short, useful and accessible article for DIY investors.

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Here’s what you need to know this week.

Older populations will affect debt costs

Credit rating agencies have warned that ageing populations will affect the quality of government debt, therefore causing the cost of borrowing to rise.

The Financial Times reported that Moody’s, S&P and Fitch have all warned that worsening demographics are already hitting governments’ credit ratings.

Older populations mean lower tax receipts and greater health and social care spending costs. This will put pressure on government budgets, making their debt riskier in the eyes of bond investors.

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According to the European Commission, the share of the population over 65 will rise from 20% to 30% by 2050, the FT reported.

S&P warned in January that in the absence of policy action to cut age-related spending, the median net general government debt will rise to 101% of gross domestic product (GDP) in advanced economies and 156% of GDP in emerging economies by 2060.

This means that just over half of the 81 countries it researches would have speculative-grade sovereign credit ratings ('BB+' or below) by 2060.

High-yield bonds or private debt?

Private debt and high-yield bonds are both at the riskier end of the fixed income world, but which will face higher defaults if there is a recession?

Fair Oaks Income,  a private debt investment trust, argues that direct loans are the safer place to be at the moment.

Its figures showed that US and European high-yield default rates, at 4.2% and 1.2% respectively at the end of April, are significantly above those of bank loans.

However, investors are worried and have been selling shares of the investment trust, pushing its yield above 15%.

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Numis, a stockbroker, thinks this makes it good value. It said: “Recent years have seen low financing costs locked into collateralised loan obligations (CLO) structures, which provides a strong base for return generation.

“The shares are currently trading at $0.49, which represents a 15% discount to the April net asset value, which uses a mark-to-market valuation approach for its CLO equity positions. We believe the 16.3% yield is attractive and the discount is supported through an active buyback programme.”