In this Q&A, Martin Horne, Head of Global Public Fixed Income, discusses the state of high yield markets amid a late-cycle environment, and why it’s critical to be nimble and selective in order to capture points of relative value.
From your perspective, where are we today when it comes to high yield, and how is that affected by interest rates? What are you seeing on the ground today?
At this point, it is undeniable that we are in a late-cycle environment. Interest rates are a reflection of where the global economy is heading—and central banks have shifted into easing mode. As a result, we’ve seen very stereotypical outflows from variable rate products like loans; we’re already seeing global yield compression; and there’s more or less global agreement that we’re in a low- growth environment. There are $15 trillion of negative yield bonds in the marketplace, which poses a significant technical and adds to the global search for yield—as investors have to be invested somewhere. In many cases, that means moving downstream from investment grade to high yield.
Despite recession-focused rhetoric from market commentators and politicians, which has contributed to erratic equity market movements, the behavior of corporate issuers suggests that we are heading for something much more measured. Similar to the recession in the 1990s, it appears that any movement downward will likely be very gradual. Credit markets tend to fare well in mild recessions, too. Spreads often stay wide, and defaults have tended to stay manageable. Credit-focused managers should be able to identify and circumnavigate the opportunity set, and do well for their investors as we move further ahead. Additionally, because the end of the cycle has been a topic of discussion for so long now, we’ve seen a gradual shift in the way corporates have positioned themselves. Finance directors and CEOs, for instance, have adjusted their return on capital assumptions, CapEx deployment processes, and inventory level expectations—all of which means corporations should be better prepared to absorb what’s coming. That said, selectivity will be critical; it is not a time to be index tracking.