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Investment grade corporate bonds
Preference: overweight

UBS View
Current global spread (26 June): 225bps (last month: 225bps)
Spread target (6-month): 170bps

• We expect investment grade (IG) corporate bonds to achieve a total return of around 3% over the next six months. Our spread target of 170bps is based on our benign economic outlook, ongoing investor appetite for income-generating assets and expected negative net issuance. This target spread is still above its 15-year average of 130bps.
• Non-financial corporates: While total yields are at record lows, the pickup over government bonds and money market rates is attractive. Aggressive re-leveraging by companies looks unlikely in the current environment. Credit quality should remain good and non-financials continue to deliver a stable income.
• Financial corporates: Due to regulatory challenges, spreads are expected to remain above past averages. Total returns could outpace non-financials, but volatility will be considerably higher.
• Overall, IG corporate bonds remain a preferred asset class, providing an attractive yield pickup. The asset class offers relatively low volatility and a benign total return outlook. We expect lower-rated issuers (BBB and A) to outperform higher-rated ones.

Positive scenario
Spread target (6-month): 140bps
• Global growth accelerates more forcefully than expected. This could compress spreads to closer to pre-crisis levels. Spreads for Financials are likely to remain elevated due to regulatory challenges. However, in this positive case, rising benchmark yields would limit total returns to 1–2% over six months.

Negative scenario
Spread target (6-month): 400bps
• Even if US economic growth falters, and the European recession turns out to be worse than currently expected, we believe we would be unlikely to see the spread levels reached in 2009, given companies’ superior balance sheet positions. European financial issuers would be most at risk in this scenario.
Note: Scenarios refer to global economic scenarios (see slide 7)

What we're watching
Core market yields
Why it matters
Developed market sovereign yields are only expected to increase gradually. A sudden rise and high volatility would hurt IG credit. Key dates: 1 August, Federal Open Market Committee meeting

Corporate fundamentals
Good corporate earnings and low leverage on corporate balance sheets should help prevent defaults.

New issuance
As companies continue to deleverage, net negative supply on the IG market should support higher prices.

Recommendations
Tactical (6 months)
• We still see room for tighter yield spreads; the return outlook compares very favorably to government bonds.
• Internationally diversified companies from non-financial sectors offer a stable and relatively safe income stream for conservative investors.
• We recommend bonds from the lower IG rating segments (BBB and A) over higher-rated issuers.

Strategic (1 to 2 years)
• We prefer corporate over sovereign assets given companies' robustness compared to the structural weakness of public finance in many countries.

Yield spreads
[Chart showing bps from 0 to 700 spanning years 2005 to 2012 comparing EUR Investment Grade and USD Investment Grade]

Source: Bloomberg, UBS CIO, as of 26.June 2012
Note: Past performance is not an indication of future returns.

UBS
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For further information please contact CIO’s asset class specialist Philipp Schöttler, philipp.schoettler@ubs.com
Please see important disclaimer and disclosures at the end of the document.
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