FAM,
T +41442842449
saemira.grancagnolo@fam.ch
Commenting on the current market outlook for the high yield asset class and specific areas of interest within this, Peter Jeggli and Kyle Kloc, Senior Portfolio Managers and jointly responsible for the Global High Yield Bond strategy, share their thoughts.
Current credit risks (defaults/risk premia)
US high yield
“At the current US spread level of around 800 basis points (bps), a default rate of around 9% is priced in. From a beta-adjusted perspective, ‘BB’-rated bonds have underperformed significantly, which is why we consider current spread levels to be favourable. Based on a default rate forecast of 5–6% for 2021, spreads should be trading in a 600–700 bps range at the end of 2020. This is based on the assumption that the coronavirus is ‘under control’ by June 2020 to the extent that an improvement in the economy in the second half of the year is foreseeable.”
EUR high yield
“The current EUR-HY spread is around 650 bps, owing to the lower share of energy names and riskier ‘CCC’-rated bonds. The EUR-HY primary market lags the US market so far. We expect better quality companies to be the first to return to the new issue market, offering an attractive new issue premium. This raises the question of which companies have potential in the ‘secured’ segment, as the market is currently only willing to lend money to companies that have the appropriate collateral.”
Fallen angels offer opportunities
“We have already seen substantial volumes of fallen angels in the US in the first quarter, with the energy, manufacturing and consumer sectors alone accounting for almost USD 100 billion. There are approximately USD 250–300 billion of ‘BBB/BBB-‘ debt of US issuers and an additional EUR 100 billion of European issuers, which are either on watch for a downgrade or is rated negative (‘outlook negative’) by at least one rating agency.”
Support from the US Federal Reserve
“The Fed is increasing its stimulus by a further USD 2,300 billion, which is enormous and corresponds to around 12% of US GDP. The focus is on credit assistance and financing for small and medium-sized enterprises. In addition, market interventions in corporate bonds, including in the high yield segment, are being expanded. However, only a small part of the high yield market is expected to be eligible for purchase by the Fed.”
Market outlook
“Rarely has an outlook been subject to such great uncertainty, as we are still at the beginning of the evaluation with regard to the medium and long-term damage to companies and the global economy as a result of Covid-19. Just as the speed and severity of the collapse is unprecedented, so are the countermeasures taken by governments and central banks.”
"We expect markets to remain highly volatile for the rest of the year. Based on historic comparisons, high yield bonds are attractively valued once again. However, further developments largely depend on the dynamics of the virus spreading. In addition to numerous monetary and fiscal policy measures, the fact that the asset class always recovered after negative years in the past gives cause for optimism. The main reason for this is that not all companies default, and the surviving companies typically switch from prioritising ‘shareholder value’ to ‘bondholder value’ in a negative credit cycle phase. In addition, the maturity profile of the HY market is comparatively short with a duration of around four years.”
Positioning within the Global High Yield strategy
“We continue to be cautiously positioned during this period of uncertainty, preferring segments with high liquidity, sectors with visibility in terms of cash flows, and companies with potentially strong government support if needed. We remain underweight in emerging market high yield, and in the retail, travel and energy space as well as in the ‘CCC’ rating segment. We are overweight in ‘BB+/BB’ rated bonds, and in telecoms and healthcare. We will use the coming months to add new fallen angels to the portfolio, which we consider viable. Based on our bottom-up credit analysis we currently incorporate a high degree of ‘quality bias’ into our portfolios.”