JPMorgan, Pimco Bet on Debt Trade Poised for Pandemic Rebound

(Bloomberg) -- Wall Street is backing a potentially lucrative trade betting on companies poised to win back investment-grade ratings in Europe's accelerating economic recovery.

Pacific Investment Management Co. and JPMorgan Chase & Co. say buying the debt of companies on the cusp of an upgrade has the potential to unlock profits. And in the wake of a pandemic that saw a record number of companies tumble into junk territory, the strategy -- known as rising-star investing -- has rarely looked so promising.

The trade has decades of business-cycle history behind it, and Pimco projects as much as 200 basis points of outperformance over the average three years it takes to exit junk. That's nothing to sniff at in a market where negative yields on corporate debt are commonplace.

Smurfit Kappa Group Plc and Stellantis NV are part of the 12.5 billion euros ($14.8 billion) stockpile of debt that's already made the jump to high-grade this year. Strategists at JPMorgan are forecasting the 2021 tally of rising stars at a record 30 billion euros -- comprising almost one-tenth of securities ranked BB.

“As vaccination efforts ramp up globally, and economic growth looks set to accelerate, we think the focus will increasingly shift toward the upgrade cycle and rising stars as we enter the second half of the year,” according to JPMorgan credit strategists led by Madhubala Sriram.

Candidates for upgrade include Valeo SA and ArcelorMittal SA, according to a note published by the U.S. bank last week.

Investors in rising stars can make attractive returns if they anticipate an upgrade before it's priced in by the broader market. That's particularly valuable at a time when investors are struggling to meet targets as the European Central Bank floods the markets with liquidity, pushing yields to near historic lows.

“Given those generic credit valuations are less attractive, now is the time also to move away from passive indexing and focusing really on bottom-up security selection, finding those rising stars,” Eve Tournier, head of European credit portfolio management at Pimco, said in an interview on Pimco's website.

Pocket of Value

BB rated bonds, which are the highest rung of the junk-rated universe, yield about 2%. That's about four times that of BBB investment-grade notes, according to Bloomberg Barclays index data.

The road to recovery may be trickier for some. Vaccinations and travel certificates are reviving the tourism industry after a disastrous 2020, for example, but the delta variant of the virus is threatening to upend progress. ING Groep NV strategists warned earlier this year of more fallen angles, or companies set to lose investment-grade credentials.

Still, the overall ratings picture is improving as corporate earnings return to pre-pandemic levels. Companies have also taken steps to shore up their balance sheets, such as reducing costs, selling non-core assets or raising equity.

Even airlines such as Deutsche Lufthansa AG and British Airways, owned by IAG SA, should be able to “claw their way back at some stage,” according to Roman Gaiser, head of fixed income and high yield EMEA at Columbia Threadneedle Investments.

“The market will likely be seeing a fair amount of rising stars over next 18 months, and we expect more rising stars than fallen angels,” Gaiser said.

Europe

Sales of ethical bonds in Europe have surged past 250 billion euros this year, smashing previous full-year records. The booming market for environmental, social and governance debt attracted issuers including the European Union, Repsol SA and Kellogg Co. in the first half of 2021.

The European Union has sent an RfP to raise further funding via a sale to be executed in the coming weeks, it said in an e-mailed statement
German property company Vivion Investments Sarl raised 340 million euros in a privately placed transaction in a bid to boost its real estate portfolio, according to people familiar with the matter
Bryn Jones, the manager of Britain's largest ethical bond fund, was ignored by U.K. government officials when he pushed for green sovereign debt years before it became mainstream. This week, he found vindication

Asia

Major Chinese ratings agencies made a record number of downgrades relative to upgrades in the first half of this year, as mainland bond defaults have occurred at their fastest-ever pace and the government seeks to overhaul the sector.

Japan's largest shipping company Nippon Yusen KK is planning to sell a note to help reduce the impact of its operations on the environment, in what would be the first such issuance in the nation

U.S.

U.S. municipal debt is proving to be one of the rare bright spots in 2021 for bond investors, who have mostly gotten pummeled by the global economy's revival. The big debate now is whether munis can extend their striking outperformance.

Sectors battered by Covid-19 are enjoying a huge resurgence in the roughly $1.3 trillion private credit market, yet another sign the economy is escaping from the pandemic
Colombia's credit rating was cut to junk by Fitch Ratings as the nation's debt outlook worsened after the government withdrew a bill to raise taxes which triggered mass civil unrest