Travel bonds: risky and expensive compared to junk bonds’ average

Bonds
Althea Spinozzi

Senior Fixed Income Strategist

Summary:  In this analysis, we look at the bonds issued by the companies listed in Saxo's Travel stocks basket. We find that travel bonds pay a lower yield and expose investors to bigger duration risk than the US junk bond's average. We also believe that recent trends in the credit bond market tell us that we are witnessing a duration event where longer maturities will be penalized over credit risk.


Amid the relentless rise in interest rates and inflation expectations, finding coupon income becomes even more crucial. Despite news report of a considerable amount of outflows from bond funds, the option-adjusted spread (OAS) of US investment grade and high yield corporate bonds remains nearly unchanged year to date. In contrast, their yield to worst (YTW), the lowest possible yield an investor would receive on a bond without defaulting, has risen slightly. The divergence between YTW and OAS in the credit space points out that any fall in price within the corporate space is mainly due to technical repricing over their benchmark. Still, the perception of risk has not changed. Looking at the US high yield corporate space, it is possible to note that the YTW has also barely moved, meaning that demand for riskier securities remains sustained despite US sovereigns continue to tumble.

The primary corporate bond market speaks for itself, indicating that it is not time to worry about a widespread selloff in the credit market because demand continues to be supported. Indeed, although last Wednesday the US high-grade bond issuance paused for a day, the successful issuance of Verizon’s jumbo bond deal on Thursday has revived corporate bond supply. However, it is important to note that high-grade corporate bonds are at a much greater risk of repricing due to their extremely heavy duration, making these securities more sensitive to changes in interest rates. As a matter of fact, while US investment-grade corporate bonds offer an average of 2.2% in yield for a duration of 8 years, the high yield bond market can offer double the yield for less than half the duration, just 3.5 years.

While we might see some signs of tiredness in the investment-grade market, this sentiment is yet not leaking to the high yield bond market for the simple reason that junk is the only asset that enables investors to lock in a yield higher than inflation expectations minimizing duration. This month, US Junk bonds are just $9 billion shy to break the monthly record issuance ever recorded. So far, around $27 billion were already sold in the month of March. On top of it, junk bond issuers can tighten spread significantly during the selling process as demand continues to be elevated.

It is becoming clearer and clear that we are witnessing is a duration event, which penalizes long maturities over credit risk.

Source: Bloomberg and Saxo Group.

The travel business's recovery turned investors' attention in recent weeks, especially in the United States. Indeed, as the vaccination pace is picking up, it is possible to expect people to resume moving freely across nations contributing to this sector's fast recovery.

My colleague Peter Garnry has put together a portfolio of 40 travel stocks, which have rebounded significantly in the past few months. Peter rightly points to the fact that current stock valuations in the travel business are approaching the highest levels since late 2015, reflecting strong expectations for profitability which may or may not materialize depending on the recovery's nature. Although the travel bond sector had also recovered since the lows of March last year, some of the bonds within these space offer a yield higher than average. To give you an example, TripAdvisor’s bonds offer a yield of around 3.5% for an average duration of one year and a half. Compared to the US high yield’s corporate average, TripAdvisor’s notes enable to reduce duration significantly while still securing a juicy yield.

In the list below, I look at the average yield and duration that notes issued by Peter’s travel basket’s companies offer. It emerges that, on average, travel bonds have a duration of around 4 years and offer around 3% in yields. It translates to the fact that travel bonds pay lower returns and expose investors to bigger duration risk than the US junk bond average.

At this point, we believe that bonds of the travel sector don’t provide an adequate return compared to the risk that they expose investors to. The biggest risk stems from unequal recovery testing companies, which have lost nearly a full year of revenues. Economic recovery can be exponential; however, travel companies’ capacity will continue to be constrained. Indeed, there are only that many rooms and seat a hotel or airplane company will be able to fill. Therefore, while the upside is limited, the downside is big and can lead to default.

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)
Full disclaimer (https://www.home.saxo/legal/saxoselect-disclaimer/disclaimer)

Saxo Bank (Schweiz) AG
Beethovenstrasse 33
CH-8002
Zürich
Switzerland

Contact Saxo

Select region

Switzerland
Switzerland

All trading carries risk. Losses can exceed deposits on margin products. You should consider whether you understand how our products work and whether you can afford to take the high risk of losing your money. To help you understand the risks involved, we have put together a general Risk Warning and a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. The KIDs can be accessed here or within the trading platform. Please note that the full prospectus can be obtained free of charge from Saxo Bank (Switzerland) ltd. or the issuer.

This website can be accessed worldwide however the information on the website is related to Saxo Bank (Switzerland) Ltd. All clients will directly engage with Saxo Bank (Switzerland) Ltd. and all client agreements will be entered into with Saxo Bank (Switzerland) Ltd. and thus governed by Swiss Law.

The content of this website represents marketing material and has not been notified or submitted to any supervisory authority.

If you contact Saxo Bank (Switzerland) Ltd. or visit this website, you acknowledge and agree that any data that you transmit to Saxo Bank (Switzerland) Ltd., either through this website, by telephone or by any other means of communication (e.g. e-mail), may be collected or recorded and transferred to other Saxo Bank Group companies or third parties in Switzerland or abroad and may be stored or otherwise processed by them or Saxo Bank (Switzerland) Ltd. You release Saxo Bank (Switzerland) Ltd. from its obligations under Swiss banking and securities dealer secrecies and, to the extent permitted by law, data protection laws as well as other laws and obligations to protect privacy. Saxo Bank (Switzerland) Ltd. has implemented appropriate technical and organizational measures to protect data from unauthorized processing and disclosure and applies appropriate safeguards to guarantee adequate protection of such data.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc.