Should global high yield weather the fixed income storm?
Jack Holmes co-manages the Artemis Funds (Lux) – Global High Yield Bond fund alongside David Ennett
Financial commentators love to use the word “unprecedented”. In most cases it is used too easily, but recent years have seen events – notably the Covid-19 shutdowns of 2020 and the resulting fiscal and monetary support on a scale never seen before – which merit The adjective.
After this remarkable episode, we are now in the midst of a period of growth, inflation and central bank tightening which – while perhaps not unprecedented – is most certainly a break from the trends seen over the past the period since the global financial crisis.
So what does this period of robust economic growth, high inflation and central bank tightening mean for high yield bonds?
Well, unlike many parts of the bond market, we believe the high yield asset class is well prepared for this environment. Basically, a high-yield bond is an instrument that converts “real” corporate cash flows into coupons paid to investors who fund those same cash-generating activities. More than $2.5 billion of cash generated by global companies is received by the global high yield market, every week, in the form of these coupons. We believe these flows are a very attractive source of return in the current environment for a number of reasons:
- High yield has low duration or sensitivity to fluctuations in government bond yields. This means that central bank policy tightening via rate hikes should affect high yield significantly less than other parts of the bond market, such as investment grade or sovereign bonds, which are more sensitive to rate moves. .
- Attractive returns or current income: Hedged to GBP, the Global High Yield Index currently offers a worst-case yield – the most conservative measure of return – of 6.9% (7.4% in USD and 5.0% in Euro). To put this into context, the MSCI World Equity Index trailing yield is 1.9%, benchmark 10-year government bonds yield between 0.2% and 2.7%, and global investment grade corporate bonds yield 3.7% (hedged to GBP; 4.2% hedged to USD and 1.8% hedged to Euro).*
- Anchored to the profitability of the company: the vast majority of income generated by the high-yield asset class comes from the “credit spread”, the extra return investors earn by taking risk by investing in corporate bonds rather than government bonds ” without risk “. The magnitude of this premium is linked to corporate profitability, which is itself linked to economic growth. With real economic growth looking robust over the next few years, the risk of default – and the possibility that the high-yield asset class will not deliver the returns it promises – is historically low.
*Source: Bloomberg and ICE BoAML. As of April 25, 2022.
Besides these attractive short-term characteristics of the asset class, we cannot ignore the structural changes that have taken place in it over the past 20 years.
While other asset classes have seen their duration increase and their credit quality deteriorate, the global high yield market has actually seen the opposite happen. As shown in the chart below, the market share of high yield in the highest quality bucket (BB) has increased significantly, while the share of CCC and underrated bonds (the highest quality bucket) has increased significantly. lower) has more than halved since the period around the global financial crisis.
High Yield has significantly increased in quality over the past 25 years
The chart below shows another measure of risk – the duration or sensitivity of each asset class to fluctuations in returns. The decrease in the sensitivity of high yield to changes in government bond yields, as well as the significant growth in government bond duration and investment grade, are in stark contrast.
High Yield’s sensitivity to yield moves has declined while other major markets have risen dramatically
So, given these attractive market characteristics, why don’t you just buy a cheap passive or quasi-passive solution?
In addition to not always being cheaper**, we believe that due to their construction they may struggle in a changing liquidity environment. Passive high yield strategies weight their exposures based on the amount of debt borrowed by issuers. This is in stark contrast to stock indices which are weighted by market capitalization, which is a good indicator of a company’s fundamental value. Lending to companies in proportion to their desire to take on debt is not.
We believe the reverse of quantitative easing will provide a significant boost to our high-conviction active management style. The unprecedented withdrawal of monetary policy support amid sustained global growth will likely lead to a return to market dispersion.