Bright prospects for the high yield market in 2024

After a strong year to date for high yield bonds, the question is: can this continue in 2024 or is a setback to be expected? The strong fundamentals and a positive technical market backdrop give us confidence that the high-yield market will continue to offer plenty of opportunities in 2024. The potentially achievable returns in global high yield markets look attractive with a yield-to-worst at around 8.5% and spreads of 424 bps currently (as measured by option-adjusted spread over government bonds). Yields have rarely been higher outside a recession. Consequently, we view this as an appealing investment proposition, especially given the fundamental strength in the market. Accordingly, a diversified portfolio of global high yield bonds constitutes one of the most interesting investment propositions in the fixed income segment.

Fundamentals in the global high yield market remain solid. A significant number of companies have improved the quality of their balance sheets in recent years. Low interest rates have led to relatively low cash interest payments, which has preserved cash. Debt levels are still moderate, with net leverage to profits (in the form of EBITDA) at ca. 3.6x in the US and 3.7x in Europe. This balance sheet improvement may slow down as issuers have to refinance their low-coupon bonds with higher-yielding debt going forward. However, the majority of companies generate sufficient cash flows to be able to service the new debt.

The relative soundness of fundamentals is also reflected in default rates, a closely watched measure for “risk” in the high yield market, which are still below long-term averages. They may increase over the coming months, considering we expect a certain deterioration in fundamentals. However, even if default rates increased slightly towards or above the long-term average (ca. 4.5%), we believe this would be driven mainly by the lower quality, more highly leveraged parts of the market. Yet, this scenario is to some degree already priced into lower quality capital structures and bonds are already trading substantially below par. Consequently, future losses are already priced into current yields to a significant degree.

The quality of the high yield bond universe underscores that the asset class is overall less risky than widely perceived. The “quality”, as measured by the average rating, has improved substantially over the last 20 years. While the share of BB-rated companies has slightly decreased in the global market due to many Rising Stars over the last two years, it is still close to 60% of the market value. Conversely, the share of CCC-rated companies remains below 10% globally, which continues to be low compared to past periods.

Furthermore, the technical backdrop for secondary market valuations remains favourable. We expect little to potentially no net new supply over the next 12 months. Firstly, many companies can afford to wait for cheaper financing conditions. Secondly, we would also expect new take-private or leveraged buy-out deals to remain subdued, given the much higher financing cost of such transactions. However, these were a major supply source over the last few years when financing was cheap.

In our view, the aforementioned factors should allow for attractive returns in the global high yield market in the absence of a major recession. Even in a recessionary environment, we would expect high-quality high yield to weather the downturn relatively well given the strong fundamentals. Consequently, we remain overall slightly defensively positioned and prefer higher quality over lower quality and non-cyclical over cyclical companies.