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Fixed Income

High Yield: A Swift Rebound

April 2019 - 2 min read

High yield bonds and loans posted a strong Q1 following the technically induced Q4 sell-off. With defaults still near historical lows, current spreads provide attractive risk-adjusted return potential.

Highlights

Global High Yield’s Quick Recovery: The notable theme of the first quarter was the swift rebound in risk assets, including senior secured loans and high yield bonds. The quick recovery in the global high yield market confirmed the notion that the sell-off late in 2018 was technical in nature and not a result of any fundamental factors. Eventually, the market found its footing as investors reentered the asset class based on attractive relative value. Global high yield bonds saw retail mutual fund inflows in January, which contributed to the market’s technical strength. U.S. loan retail funds saw continued outflows, but at a much slower pace than in late 2018, and these were more than offset by CLO activity and institutional investor demand.

Bonds Outperform Loans: While both asset classes continued to generate positive returns throughout the first quarter, high yield bond spreads saw more significant tightening than senior secured loans. The global high yield bond option-adjusted spread tightened by 126 basis points (bps), to end the quarter at 410 bps. Global senior secured loans, as measured by the 3-year discount margin, were 75 bps tighter, to end the quarter at 459 bps. An increasingly dovish posture from central bankers pushed down risk-free rates, buoying demand for fixed rate assets. Global high yield bonds and global senior secured loans returned 7.07% and 3.53% during the quarter, respectively.1,2

Outlook

  • Technicals Appear Supportive Going Forward: The high yield bond market exhibited significant technical strength during the first quarter, driven by a more dovish Fed, stable to improving commodity prices, and limited new issue supply. There are still several key macro stories that could create volatility in the coming months, including Brexit and U.S.-China trade negotiations, but overall we are constructive on our outlook for the global high yield markets—a position we discussed in our recent piece, High Yield: Five Takeaways for the Months Ahead. While there have been a few large transactions priced this year, the primary market calendar has generally been quiet, and we believe this will remain the case in the near-term. This supply and demand imbalance should help sustain the supportive technical environment.
     
  • While Growth May Slow, Fundamentals Should Remain Stable: After posting generally strong results in 2018, we expect the rate of revenue and earnings growth to potentially slow in 2019, but to remain positive nonetheless. Default rates continue to be at very low levels, and the outlook for new defaults is muted. Sectors like energy and retail will continue to be challenged by secular changes and global macro factors, but overall we think corporate balance sheets are relatively healthy. Prudent asset selection and risk management will continue to drive returns in global high yield.
     
  • Current Spreads Can Provide Attractive Risk-Adjusted Opportunities: We believe that corporate fundamentals are strong and default rates will remain low. At current spread levels in the low to mid 400s, global high yield bonds and global senior secured loans continue to provide attractive risk-adjusted return opportunities for investors.

Global Loan and High Yield Bond Spreads1,21. Source: BAML Non-Financial Developed Markets High Yield Constrained Index (HNDC). As of March 31, 2019.
2. Source: Global Loan Index Weighted Discount Margin (3-year life). As of March 31, 2019.

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