Roland, High yield bonds offer record yields in some cases - they are finally living up to their name again.
That’s true, the asset class is currently on track to deliver high single digit total returns in 2023 which is a pretty solid outcome for a period that includes a regional bank crisis, the failure of a major European investment bank and persistent rate hikes from the Fed and ECB. Not to mention the very consensus view that we are teetering on the edge of a recession.
How to act with a looming recession in sight?
In a challenging market environment we try to balance risk and opportunities. We however believe it's not yet time to be fully defensive given the high carry, thriving primary market and still solid company fundamentals. But we acknowledge that the environment is becoming more difficult and growth momentum is cooling off. Hence we avoid big bets in either direction, we avoid companies which are overleveraged and have a refinancing hurdle within the next two years and we move up in quality. What should also be noted: the high yield market has massively evolved over the years in terms of overall rating quality.
Can you shed some light on that?
Sure, in Europe 68 percent of the High Yield Universe is rated BB, in the US it’s a bit less with roughly 50 percent being BB rated. Nevertheless, this constitutes a 20 percent increase in BBs in the last 20 years. At the same time the amount of CCC rated issues declined. In addition, the market has become more diversified. In the past, the high-yield market was dominated by very large single industries like energy in the US or Telecom in Europe. Today these sectors are substantially smaller and the universe is more diverse. Additionally, the number of large caps in high yield with global or national champions such as Ford or Lufthansa has also grown. Large corporations tend to have better and more diversified access to funding. A smaller company usually has only a single channel open for funding. Diversification is key in a downturn and hence yes, we do firmly believe that the high yield market is more resilient than in the past.
Which duration do you prefer?
Duration is not really a key performance driver in a high yield portfolio. Having said that, we have recently moved from an underweight to a more neutral position in duration given that we think we are at or close to peak inflation.
And what is your assessment regarding sectors and regions?
From a sector perspective we like industries that have momentum and improving or at least stable fundamentals which is for instance anything leisure related. Airports, airlines, recreational parks or gaming companies continue to produce stellar earnings quarter after quarter. Automotive is another sector with good momentum due to strong orderbooks. Supply chain issues have been mostly resolved and lower raw material prices point to margin expansion over the next 1-2 quarters.
Which sectors should you be careful with?
In Europe, the high yield sector we like the least is real estate. We are almost entirely underweight. We believe the European real estate sector is massively over-leveraged, the business model does hardly work in the current yield environment and these companies have lost complete access to the capital market. In the US Media is in a similar situation, overleveraged and a broken business model. We expect continued stress and more defaults in these sectors.
What do you prefer? Secured or unsecured bonds?
Within capital structures we clearly prefer secured over unsecured bonds. Secured bonds tend to protect its value much better in a downturn than unsecured bonds due to the collateral value and preferred treatment in a restructuring. Year to date the secured high yield index already outperformed the ICE BofA Global High Yield Index by more than 1 percent which emphasizes the importance of quality bias in the current environment. We believe secured high yield bonds are a great way to participate in the current attractive yield environment while positioning more defensively.
