Investors could look to non-core covered bonds and longer maturities, as well as other types of bank debt and SSAs, to counter expectations of continued depressed covered bond spreads and yields in 2021, according to investor surveys conducted by ABN Amro and Natixis.

ABN Amro surveyed a total of 108 investors in its general fixed income survey, of whom about 55 answered the covered bond-specific questions, while 47 investors representing a cross-section of countries and investor types participated in Natixis’s covered bond investor survey.

Covid-19 not surprisingly casts its shadow over 2021, with over half of all respondents to ABN Amro’s survey citing it as the biggest risk to the macro outlook. Most expect the 10 year Bund yield to remain in deeply negative territory at the end of next year, with an average forecast of minus 0.45%, and a third expecting it to be even lower than today.

However, Natixis found key themes among covered bond investors to be not dissimilar to those that have dominated not just during the pandemic, but in pre-coronavirus days.

“Putting aside the Covid-19 crisis, the main concerns were over spread levels, the yield environment, the ECB’s purchase programme, and liquidity,” said Jennifer Levy, senior analyst, covered bonds and agency markets at Natixis.

Biggest concerns when investing in covered bonds in 2021

Source: Natixis

ABN Amro and Natixis found similar expectations among investors on the direction of covered bond spreads, with a clear majority anticipating a tightening of up to 10bp, but a significant minority expecting a widening: 73% of ABN Amro’s respondents expect up to 10bp of tightening, and 27% a widening of up to 10bp, while 42% of Natixis’s see up to 5bp of tightening, 10% 5p-10bp of tightening, and 35% a widening of 2bp-10bp. However, only around 13% of ABN Amro’s respondents cited expected tightening as a reason why they will continue to buy covered bonds in 2021.

Almost two-thirds of ABN Amro’s respondents expect to rebalance their portfolios towards SSAs, with close to 40% seeing SSAs as attractive versus covered bonds and others citing the greater supply of SSAs at a time when covered bond issuance will be limited. However, more than 50% of respondents to Natixis’s survey – more focused on covered bond investors – consider covered bonds to be attractive versus core government bonds as well as supranationals and agencies.

Natixis found a bias towards a reduction in covered bond holdings, with 88% of investors surveyed planning to reduce or maintain their positions versus 74% saying they will maintain or increase them.

More than 60% of respondents to ABN Amro said they will rebalance their portfolios in reaction to negative yields when it comes to covered bonds. Around 20% will lengthen duration, 18% will add new, higher-yielding jurisdictions, and 22% will shift towards riskier bank debt. Insurers are most likely to increase duration, with 78% expecting to do so by around three years.

“This illustrates that the hunt for yield will be a key theme for investors in 2021, with most willing to add more risk to their portfolios,” said Joost Beaumont, senior covered bond analyst at ABN Amro.

Natixis also found that 33% of investors have already lengthened duration in response to developments during the pandemic, while 29% have reduced their covered bond investments and 38% have focused on core and semi-core covered bonds. Some 53% of respondents said they prefer to focus on eight years or longer, and 30% on the six to seven year part of the curve.

Non-Eurozone covered bonds proved popular in Natixis’s survey, with 46% of respondents believing them to offer the best risk/reward when investing in covered bonds. Among ABN Amro’s respondents, Canada was seen as having the best relative value by the second-highest number of investors, with semi-core most popular and the periphery third-most popular.

Where do you see higher relative value?
% share of region in total mentions

Source: ABN Amro

The end of the Brexit transition period will see 61% of investors decrease or stop investing in UK covered bonds, according to Natixis’s survey, up from the 48% who expected to last year.

Although 49% of investors told Natixis they cannot invest in the relatively new jurisdictions of CEE, Japan and South Korea, 41% said they can buy CEE covered bonds, 41% Japanese and 38% South Korean.

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