Public Fixed Income

Is High Yield in a Sweet Spot?

April 2021 – 7 min read
High yield continues to benefit from supportive tailwinds—from an improving default picture to lower sensitivity to rising rates—and may be poised for strong performance as the recovery takes hold.

The post-pandemic high yield market is coming into focus. While it will take time for economic activity to return to normal, particularly given rising COVID cases in some parts of the world, expectations remain for a strong recovery in the months and year ahead.

Rising rates continue to dominate headlines, and it is perhaps no surprise that loans have outperformed bonds to start the year, returning roughly 2% in both the U.S. and Europe.1 However, while there are certainly benefits to floating rate assets like loans in a reflationary environment, high yield bonds also look relatively well-positioned, particularly in Europe, where returns reached 1.6% for the quarter given the market’s insulation from U.S. Treasury yield volatility. U.S. high yield bonds, despite lagging the broader high yield market, have shown resilience relative to some other fixed income asset classes, returning 0.95%.2 This is due in part to the asset class’ shorter duration profile—whereas investment grade corporates, for instance, have an average duration of slightly more than seven years, high yield bonds have a duration of roughly four.3
 

Early Signs of Recovery

From a fundamental standpoint, default expectations continue to improve. Given that distressed ratios are at multi-year lows and both the bond and loan markets are awash with liquidity, we believe defaults this year could fall in line with historical averages of between 2–3%. For comparison, high yield bond and loan defaults ranged from 3–5% last year—much lower than the double digits some initial forecasts were calling for, thanks in large part to the massive global stimulus measures.4 At the same time, earnings, revenues and cash flows are expected to surge higher this year and into 2022 as consumer demand returns.

Given the positive performance of the asset class and improving default expectations, spreads have tightened significantly in recent months, leading to questions around valuations. While bond and loan spreads do appear tight relative to historical averages, the question of valuations is more nuanced—for a few reasons. For one, while spreads have tightened recently, they remain favorable relative to higher-rated corporates, some of which are trading at or near record tights. High yield bonds continue to trade wider than 2017/2018 market cycle lows, for instance, while loans continue to trade wider than both pre and post-GFC tights.
 

1. Source: Credit Suisse. As of March 31, 2021. 
2. Source: Bank of America Merrill Lynch. As of March 31, 2021. 
3. Source: Bank of America Merrill Lynch. 
4. Source: S&P; Credit Suisse. As of December 31, 2020.

Want to read the full article?

View PDF

Martin Horne

Global Head of Public Assets, Head of Barings Europe

Any forecasts in this material are based upon Barings opinion of the market at the date of preparation and are subject to change without notice, dependent upon many factors. Any prediction, projection or forecast is not necessarily indicative of the future or likely performance. Investment involves risk. The value of any investments and any income generated may go down as well as up and is not guaranteed by Barings or any other person. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.

Any investment results, portfolio compositions and or examples set forth in this material are provided for illustrative purposes only and are not indicative of any future investment results, future portfolio composition or investments. The composition, size of, and risks associated with an investment may differ substantially from any examples set forth in this material No representation is made that an investment will be profitable or will not incur losses. Where appropriate, changes in the currency exchange rates may affect the value of investments. Prospective investors should read the offering documents, if applicable, for the details and specific risk factors of any Fund/Strategy discussed in this material.

Barings is the brand name for the worldwide asset management and associated businesses of Barings LLC and its global affiliates. Barings Securities LLC, Barings (U.K.) Limited, Barings Global Advisers Limited, Barings Australia Pty Ltd, Barings Japan Limited, Baring Asset Management Limited, Baring International Investment Limited, Baring Fund Managers Limited, Baring International Fund Managers (Ireland) Limited, Baring Asset Management (Asia) Limited, Baring SICE (Taiwan) Limited, Baring Asset Management Switzerland Sarl, and Baring Asset Management Korea Limited each are affiliated financial service companies owned by Barings LLC (each, individually, an “Affiliate”).

NO OFFER: The material is for informational purposes only and is not an offer or solicitation for the purchase or sale of any financial instrument or service in any jurisdiction. The material herein was prepared without any consideration of the investment objectives, financial situation or particular needs of anyone who may receive it. This material is not, and must not be treated as, investment advice, an investment recommendation, investment research, or a recommendation about the suitability or appropriateness of any security, commodity, investment, or particular investment strategy, and must not be construed as a projection or prediction.

Unless otherwise mentioned, the views contained in this material are those of Barings. These views are made in good faith in relation to the facts known at the time of preparation and are subject to change without notice. Individual portfolio management teams may hold different views than the views expressed herein and may make different investment decisions for different clients. Parts of this material may be based on information received from sources we believe to be reliable. Although every effort is taken to ensure that the information contained in this material is accurate, Barings makes no representation or warranty, express or implied, regarding the accuracy, completeness or adequacy of the information.

Any service, security, investment or product outlined in this material may not be suitable for a prospective investor or available in their jurisdiction. Copyright in this material is owned by Barings. Information in this material may be used for your own personal use, but may not be altered, reproduced or distributed without Barings’ consent.

Related Viewpoints