High-yield bonds: Focus on quality is key

As we approach mid-year, the global high-yield market is in positive territory, depending on index and currency, with gains of between 2.5 and 3 per cent. This is a solid interim result after the enormously strong returns witnessed in the previous year. In view of the favourable environment, the market is currently characterised by a narrowing of credit spreads. Spreads over government bonds in the global high-yield bond market are currently around 345 basis points. However, this is not an exceptionally low level. Credit spreads of this magnitude were last seen repeatedly from 2017 to 2021.

The prevailing yields offered by the asset class are still high, providing a solid buffer in the event of any widening of spreads. In general, valuations in the market are relatively high due to the continued sound fundamentals of companies, but are also largely justified. For investors, the current valuations make it all the more important to scrutinise sectors and companies in order to both exploit opportunities and recognise, and mitigate, existing risks.

In view of the uncertain market outlook, we believe that quality is paramount for high-yield bonds, but it is precisely these corporate bonds that are priced accordingly. In the highest rating category of the high-yield market, the double-B segment, short-term bonds appear to us to be the most promising. Due to the inverted yield curve, there are attractive yields to harness at the short end, while it is often not worth investing in longer-dated bonds in this segment, given the flat credit curves. At the same time, the credit risk is rather low. And there should rarely be any problems with refinancing in this segment.

At first glance, the CCC segment appears to offer the most opportunities. In our view, however, caution is required here, as numerous companies in this rating category were able to refinance themselves relatively cheaply in the extremely low interest rate environment, but have not yet refinanced a large proportion of this debt at higher coupons. This could lead to problems for these companies when these securities mature in the coming years. In our view, prudent selection in the single B segment is therefore important. There are still interesting securities here that are not binary in nature, like some of those in the CCC segment, and in-depth bond selection should prove rewarding.

From a sector perspective, we are overweighting basic industries, capital goods and energy, the latter of which accounts for a high proportion of the high-yield market, particularly in the US. In contrast, our globally diversified portfolio has the largest underweights in the technology sector and financial services. The valuation gap in the high-yield market between the US and Europe has recently narrowed significantly, meaning that we are currently more neutrally positioned from a regional perspective, having recently favoured Europe.

So far this year, the high-yield bond market has received technical support due to the continued low volume of new issues, which is supporting prices on the secondary market. The fundamentals of numerous companies have also continued to impress. Europe's economy appears to have bottomed out, while the economic slowdown in the US is heading towards a soft landing. Although the fight against inflation has yet to be fully completed, it has proved somewhat successful thus far. We therefore believe that the current yield of 7.5 per cent in US dollars for global high-yield bonds remains attractive – especially when considering the risk/return profile within the entire bond universe. In our view, however, investors should not actively emphasise risk in their portfolios at present in view of uncertainties, such as economic developments and geopolitical crises.