When it comes to investing, some anomalies can surprise you. One example is that bonds issued by software giant Microsoft (which have a AAA rating) are considered ‘safer’ than Treasuries issued by the US government (AA+), a point made by FE fundinfo Alpha Manager Richard Woolnough, speaking at the M&G Bond Vigilantes conference in London.
But Microsoft’s bonds are far from alone in being higher rated than Treasuries.
“If you plotted it at the aggregate level, government bonds seem to be getting lower and lower rated whereas the quality of the [corporate credit] universe is improving,” he said.
“It is quite interesting that public versus private argument, which we focus on all the time. When we want to buy an asset what risk do we want to take? [Is it] government, emerging market, high yield [or corporate credit]?”
Lloyd Harris, head of fixed income at Premier Miton Investors, said it is not uncommon for investment-grade corporate bonds to trade inside government bonds.
For example, UK-listed international banking group HSBC traded inside gilts for a short period of time during the financial crisis.
So are Microsoft’s bonds a safer bet than US Treasuries?
For Nick Hayes, a portfolio manager at AXA Investment Managers, the risks between bonds issued by Microsoft and the US government are similar. He noted the market is “efficient enough to work out that the default risk on bonds such as Microsoft is very, very low”.
“Particularly given the strength of the business and the balance sheet, which is ultimately reflected in the strong credit rating but also the (minimal) spread premium that you can get in AAA corporate bonds over US Treasuries,” he said.
Microsoft’s bonds and US Treasuries carry “very similar” interest risk – in other words, they could suffer if inflation rises and interest rate expectations alter.
“Both, we think offer attractive valuations at the moment. In other words, they are risks worth taking,” he concluded.
Shamil Gohil, fixed income portfolio manager at Fidelity International, said deciding which is the better investment will depend on various factors. He agreed that looking at ratings alone, Microsoft is the ‘safer’ bet.
“Based purely off the expected probability of default and loss given default, in the case of Microsoft versus US Treasuries, then clearly yes, Microsoft is safer,” he said.
“However, rating agency methodologies differ from asset class to asset class, so we are comparing apples to oranges. If we look at credit spreads, that would imply the market perceives Microsoft as a riskier investment than US government debt as it trades 25-50 basis points (bps) over Treasuries.”
However, credit spread is not just a measure of credit risk, but liquidity premium as well. He noted that an AAA tranche of collateralised loan obligations (CLOs) or asset-backed securities (ABS) are also perceived as ‘safer’ than US Treasuries and as risk-free as Microsoft.
“But that trades at 100bps spread, implying a much riskier investment than government and corporate bonds. Therefore, looking at ratings alone does not tell you how safe a credit is, the market is probably a better judge of that,” Gohil noted.
Although Microsoft is a “highly cash generative business with low leverage and global revenues” there are risks with buying its bonds, including that it is “exposed to changing technological risks in the future”.
Conversely, the US government continues to “borrow more and more with debt/GDP climbing to arguably unsustainable levels,” which is the biggest concern for investors, but it can print money during times of stress, something corporates cannot do in a credit crunch.
Harris concurred, noting the reason corporate bonds tend not to trade permanently inside government bonds is because governments can print money.
“This is why there aren’t corporates that trade inside Japanese government bonds, even though Japan is single A-rated and there’s plenty of higher-rated corporates, because Japan can just fire up the printing press and buy its own bonds,” he said.
One area of exception could be Europe, however, where individual countries within the Eurozone can’t print their own money. This makes it “certainly possible” to suggest that some European companies are theoretically safer than their country’s government bonds.
Joost Van Leenders, senior investment strategist at Van Lanschot Kempen, noted for spread on all investment-grade corporate bonds.
“This includes some default risk, but it is more about volatility. Economic and political risks have increased in some developed markets, which can lead to more volatility in their bond yields. It is especially this potential volatility which is priced in the spreads,” he said.
Another area where Microsoft and other US or European-listed multinationals might have the upper hand is versus emerging market government bonds, as they can be “less volatile than an investment in a weak emerging economy”, he concluded.