Author: Luca Manera, Investment Manager, Asteria IM
Octobre 2022
The return of the coupon
Fixed income investors have suffered for way too long. Coupon returns have eroded month after month over the past ten years as all-in bond yields continued to decline into negative territory, this is especially true for European bond investors. The notion of “fixed-income” is associated with the recurring and “fixed” coupon payment of a bond that provides a stable stream of cash-flows. In fact, coupons are a key source of return, especially for those investors seeking stable income. The good news is that coupon rates and as a result returns are already recovering from the recent historical lows of 2022, offering a glimpse of hope that fixed income will regain its fame as a provider of income.
Coupons are fixed at issuance, reflecting the current level of interest-rates and credit spreads (market and issuer specific); when the yield is set to be the same as the coupon rate the bond price is 100. While there can be significant differences of coupon-rates from an issuer to another, we look at index level data as this will largely reflect the broad coupon rate of the market.
Don’t look back in anger
As central banks cut interest rates over the past decade and embarked in quantitative easing this has pushed yields down (prices up), but at the cost of falling coupon rates. Consequently, this has translated into declining coupon
European coupons returns have declined since 2008 to historical lows in 2022 but are starting to recover.
returns for investors (approximated as the difference between the total return and the price return). As a result, the coupon rate has fallen across fixed income markets noticeably in Europe, with the Euro Government index coupon rate declining from 4% in 2011 to 2% in 2022 and the Euro Corporate index coupon rate falling from 3% to 1.6% by September 2022.
*The 6-month average of monthly coupon returns, approximated as Total Return net of Price Return
Sources: Asteria IM, ICE Index
Since 2018, the average monthly coupon return was of just 15bps and recorded the lowest monthly return in Q1’22.
This contrasts significantly with prior years when coupon returns could contribute more than 30bps a month of performance for investors. Even when considering the changes in historical composition of the indices which should support a higher coupon rate such as increasing duration and growth in lower rated cohort, the decline in coupon rate has removed a key source of return for bond investors.
Coupons are back!
Despite this year’s historically challenging performance for investors, driven by fast rising interest-rates and credit spreads, the increasing yields are starting to be reflected in higher coupons for new bond issues. The best point in case is Germany (AAA-rated) which was able to issue bonds with a 0% coupon and negative yields over the past years and in September it issued a 5-year bond with a coupon of 1.3%. Likewise, one of the largest corporate issuers in Europe, Volkswagen (A3-rated) was previously able to issue senior unsecured bonds with coupon rates below 1.5%, this contrasts with the 3.75% coupon of its recently issued 5-year bond in June.
Coupons are back! New bond issues offer a coupon rate more than double than what is available in the secondary market*
*Only EUR Corporate senior unsecured bonds
Sources: Asteria IM, ICE Index
After the (volatile) summer-lull, new bond issuance caught up in September, with over 60 new bond issues in the Euro Corporate investment grade universe amounting to over EUR45bn across ratings, sectors and tenors. Noticeably, the median new issue coupon rate was 3.2%, eclipsing the rate available in the secondary market of just 1.2% (August index as proxy). Even when adjusting the coupon rate by the hefty price discounts available in the secondary market (measured as the current yield), new issues continue to offer an attractive alternative for investors: with a coupon return of 28bps compared to the meagre 13bps of the index.
Higher and green coupons are here to stay
The current macro-economic environment of high inflation, recessionary fears and tightening of monetary policy along with volatile market conditions all point to continued high level of bond yields. Even in a scenario where central banks pivot and there is a shallow recession, coupon rates will continue to adjust upwards from historically low levels as new issues catch-up with the level of interest rates and credit spreads.
This holds true across all types of fixed income markets whether green or vanilla. A recent and noticeable example is the four-tranche green bond issue in October of TenneT, the Dutch owned electricity transmission operator and A-3 rated. The average coupon rate was in excess of 4%, this compares to an average coupon of around 2% for its last issuance in May 2022.
Stay selective and take advantage of the return of the coupon
As markets head into an uncertain winter in Europe, a slowing US economy and a fragile Chinese recovery, we continue to maintain our cautious view on credit markets and actively remain selective, even for new bond issues. Especially in the current market outlook, bond investors can now finally take advantage of an additional source of performance for their portfolios and benefit from higher coupon returns.
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