This article was produced in partnership with T. Rowe Price
While usually seen as the domain of equity investors, T. Rowe Price portfolio manager and vice president Mike Della Vedova says high-yield bonds are emerging as a unique exposure to megatrends like artificial intelligence (AI) and GLP-1 drugs.
But it’s not quite as simple as buying a Magnificent Seven US tech stock.
“You have to do a bit more work than ringing up your broker and saying ‘buy Nvidia’,” the Australian-born, London-based portfolio manager tells Professional Planner, referencing the Nasdaq-listed tech darling whose shares have risen 180 per cent over the past 12 months.
“It’s not like that in our world. Nvidia is providing the picks and shovels for the gold rush. We’re looking for the folks who are providing the handles and the heads of the picks and shovels, the factories where the picks and shovels are being built and the places they’re being sold from.”
There are strong examples of companies who meet this unique criteria issuing bonds in the past few months, Della Vedova adds.
The opportunity stemming from AI is one of the reasons why companies issuing bonds that are BBB-rated or below, which T. Rowe Price invests in as part of its Global High Income strategy, should be experiencing a renaissance, Della Vedova says.
A particular opportunity is brewing also, he says, in companies involved in the production of “graphic processing cards” as part of the additional computation needed to power the AI revolution. And there are attractive investments relating to the data centres and server rooms underlying the AI megatrend – both in the hardware required and also the energy generation.
“If you want to have the opportunity to invest, companies will come to market to raise capital to improve their ability to generate electricity. But you lend to companies when they’re looking to have capex [capital expenditure] needs, when there’s almost a guaranteed outtake, guaranteed demand for their product. We’re seeing that demand increase.”
These kinds of opportunities in capital-seeking companies involved in energy, and the heating and cooling of data centres, are an example of the kinds of investments beyond those dominating the mainstream financial news coverage.
To that end, the strategy can also be a way to gain exposure to the dramatic shifts underway in electricity generation and the energy transition to a low-carbon economy. He estimates that about 3 per cent of the global high yield investible universe is involved in electricity generation in some capacity.
Obesity opportunity
High-yield bonds can provide a unique exposure to the secular mega-trend of healthcare innovation, Della Vedova argues. The emergence of glucagon-like peptide 1 (GLP-1) medications to treat obesity and diabetes, for example, brings opportunities – but also some threats that investors in sub-investment grade credit will need to be alert to.
He explains that, traditionally, dialysis providers have traditionally been a big part of the high-yield credit investible universe. This has been a growing opportunity amid a growing middle class in both advanced markets like the US and emerging markets around the world.
But the rise of GLP-1s is reducing the need for dialysis in the long term. “That’s a good thing – there’ll be healthier people,” Della Vedova adds, speaking to the social and environmental impact. But there will still be a long-term impact on these companies involved in dialysis or related chemical production.
On the flipside, there is an emerging opportunity for so-called contracted research organisations (CROs), a number of which are included in the high-yield market. As demand for these new drugs surges, there will be adjacent need for companies involved in testing and research, regulatory approvals and innovation in delivery systems, such as moving from injection to oral methods.
There are also flow-on effects from the advent of GLP-1s for companies in the aged- or managed-care industries, because effective obesity and diabetes medication will ensure that in-patients are healthier, live longer and have fewer acute medical care needs, triggering a potential decrease in costs.
More interesting (and more boring)
The quantum of that opportunity is creating a resurgence of demand, he says, as the market begins to realise there are reasons to look beyond the “investment grade” labels from research and ratings houses.
“Companies require capital all over the world, and not all of them are seen as investment grade by the ratings houses,” he says. “But not all these companies are not investment grade for bad reasons.”
He draws an analogy between a company taking on debt to pursue its M&A or growth ambitions and a family taking on a larger mortgage in order to move into a larger home.
“It costs money, and the debt pile goes up, but there’s a real reason,” he says. “Other times a business might just be in a cyclical decline – it could be a commodity, it could be a market downturn. Or it could be that a company is underperforming for a range of reasons – perhaps they’ve expanded, or see an opportunity or [are] building a new plant or a factory somewhere and it’s a long-term positive.”
At the same time, Della Vedova stresses that doesn’t mean you should recommend clients buy any sub-investment grade bonds on the market. “You pick your spots, you don’t buy everything, you say no a lot more than you say yes. If you can do that [pick winners], you get [a] greater chance to make income and returns for your clients without embedding additional risk.”
He says high-yield bonds are inherently a mid- to long-term proposition because companies with sub-investment grade credit do not “fix themselves in weeks or even quarters”. He says advisers should keep in mind that, unlike equities who ordinarily pay dividends at management or board discretion, bonds will provide income necessarily by way of the coupon.
He describes this characteristic of the market as being both “more interesting and more boring” than investing in equities – more interesting because of the vast diversity on offer; and more boring because of the timeframes involved and income focus, with investors capitalising as the quality of the company incrementally increases and the risk associated with its credit profile declines.
“So, it can take more work, but there are a lot of opportunities.”
