Around 18.8% of corporate bond issuers in the UK could enter the high-risk bracket as the likelihood of defaults rise.
By Tom Aylott,
One in five UK companies is likely to have its creditworthiness downgraded, according to a study by analytics platform, bondIT.
It found that 18.8% of corporate bond issuers in the UK could have their credit rating lowered as economic pressures increase their likelihood of defaulting.
Comparatively, only 15.4% of UK companies are likely to have their credit rating upgraded, with 65.1% remaining in the same bracket.
Credit rating change predictions
|High Downgrade Probability
|High Upgrade Probability
With interest rates reaching 3% and inflation rising to a 40-year high of 11.1%, businesses in the UK have been under more pressure than much of the past decade.
David Curtis, head of global client business at BondIT, said: “There’s now a greater number of corporates that are at risk of their credit rating deteriorating.
“We think there’s a higher likelihood of credit transition than there has been previously. Transition means they move to a lower credit notch, so there’s less likelihood they pay you back, but they can still be solvent businesses.”
Although the outlook for UK corporate bonds may look poor, the study’s findings can be used to an investor’s advantage.
Cautious investors can reduce exposure from higher-risk sectors and move into safer areas, while those with a higher risk threshold can enter them and make use of higher yields.
Curtis added: “As people allocate more into bonds and fixed income, they need to think about what sectors they’re exposing themselves to.
“Are they exposing themselves to areas that are robust and able to come through these forecast recessions successfully, or are they putting their capital at risk? That’s not really the point of investing in bonds.”
Either way, Curtis said that investing in the corporate bonds of a company could be a more attractive option than buying its shares in this environment.
Investors could lose money through volatile equities, but corporate bonds offer a fixed income throughout market turmoil provided the issuer doesn’t default.
Curtis said: “If the share price is down, that means you have lost money, but for the bond, it doesn’t mean you’re less likely to get your money back when it reaches maturity
“You’re paid to wait with bonds – nothing needs to happen. If you buy equities, these markets have can be very volatile, but the beauty of bonds is that they redeem most of the time.”
Sharmin Rahman, manager on the global fixed Income team at Liontrust, agreed that corporate bonds could shield portfolios from volatility in equity markets, but urged investors to be cautious on where they invest.
With default rates expected to rise, investors could lose money in the corporate bond market if they’re not careful.
Rahman said: “Default rates are currently low, but we anticipate this to rise given the looming recessionary period, so for investment managers stock selection is key.
“If a company defaults, the equity value would typically be wiped out, whereas bondholders would be in a more favourable position as they have some security on the company’s assets, with potential recovery value.”
Airline companies are at the greatest risk, with 31% of businesses in the sector forecast to be downgraded, according to the report.
Default risk by sector
Similarly, 30% of travel and tourism businesses could also be downgraded as consumers spend less on luxuries and more on everyday expenses in the cost-of-living crisis.
However, the biggest increase of risk was in the household goods sector, with downgrade risk increasing by 13 percentage points between the second and third quarter to 29%.
Indeed, household goods companies also leapt 6 percentage points over the period, reaching a 30% downgrade risk level.