- Healthier balance sheets and options for refinancing make high yield environment more attractive.
- Only 6% of high yield bonds redeem this year, with most maturing in 2025.
- Default rates expected to rise but remain relatively muted.
The outlook for high yield
With developed central banks hiking interest rates over the last 18 months+ in a bid to cut inflation, we are starting to see the impact of higher rates on macro-economic indicators. As this continues through the end of 2023 and into next year, conversations have turned to how best to position portfolios for a downturn. We think high yield bonds present an opportunity within the fixed interest space.
What are high yield bonds?
High yield bonds are named as such because they typically carry a higher income stream than government bonds or corporate investment grade credit. However, this higher income is indicative of a higher risk of the issuer defaulting on interest payments, with issuers usually carrying a lower credit rating.
The case for high yield
Generally speaking, balance sheets are stronger now than at the start of previous downturns. Though a recessionary environment would see profits suffer, many firms took advantage of attractive terms for financing during the Covid years for 2020 and 2021, when interest rates were at rock bottom.
Only 6% of high yield bonds will mature this year – with very few companies having to refinance their debt burdens at a time when rates are at their highest in two decades. The majority of high yield bonds hit their maturity dates in 2025, and so have headroom to refinance in the coming 12-18 months. In addition, much of the high yield market sits within the higher credit grades, making it easier to obtain financing from banks and investors on better terms.
Whilst default rates within the high yield market are expected to rise in a recession, commentators believe these will remain relatively subdued, though above the long-term trend of 1.8%. High yield as an asset class has the ability to generate healthy returns for investors, with many riskier bonds having seen prices fall through the rate hiking cycle, and the elevated yields at which investors can enter the market make high yield a difficult proposition to pass up.
Portfolios currently hold an exposure to high yield, concentrating on the short end of the yield curve, which we feel will react first to policy adjustments when they arrive. Our allocated fund provides an internal yield of around 7.8% and performance is up 3.6% so far this year. This strategy is mainly focussed within the US, where we feel a downturn would be less impactful.