A quick look at a timely topic of interest - with a brief review of why it could matter to investors.

Chart of the Week

October 27, 2014

HY bonds: ups and downs
Barclays US Corporate High Yield Index: yield to worst & daily change in yield

chart

Source: Bloomberg, as of 10/22/14. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

The bottom line:

  • Equity investors aren't the only ones who've seen heightened volatility lately: it's been a factor in the high yield (HY) sector since mid-summer.
  • Since yields bottomed on June 20, the average daily move in yield is more than twice as large as it was prior to that this year.
  • HY investors have shared some of the same recent concerns as stock investors, including uncertainty about the impact of slower global growth on US growth and the potential impact of a future Federal Reserve (Fed) rate increase.
  • Another factor specific to the HY market was the impact of greater-than-anticipated redemptions by mutual fund investors. As a result, some HY managers were forced to sell bonds to raise cash to meet outflows, and in the process, lost the opportunity to bid on new issues – helping to push yields higher.
  • Overall, yield to worst (YTW) for the sector stood at 5.89% on Oct 22—101 basis points (bps) higher than it was on June 20th. However, in absolute terms, that level remains appealing under current conditions—especially compared to a 10yr US Treasury yield of just 2.21%.
  • Concerns about the Fed are sure to linger—higher rates would be a headwind for all bonds. However, it's possible the Fed may opt to raise rates at a measured pace, without materially tightening financial conditions.
  • If so, that would suggest little change to fundamentals, which are arguably also little changed from June: the US economic outlook is mildly improving, central bank monetary accommodation is ongoing, default rates for HY remain low and balance sheets of companies issuing high yield paper are generally solid.
  • Meanwhile, the potential advantage of a flexible and diversified bond strategy is accentuated by the fact that the index yield dropped 58bps and its option-adjusted spread (OAS) narrowed 61bps between 10/15 and 10/22.

The chart:

  • The chart shows the YTW of the Barclays US Corporate High Yield Bond Index and the daily change in that yield for 2014 through October 22nd.
  • The YTW of the Barclays US Corporate High Yield Bond Index reached a record low of 4.83% on June 20, 2014, but since then has backed up reaching a recent high of 6.47% on October 15, 2014, but declining 58bps in just four trading days to 5.89% on October 22, 2014.
  • The average daily move in yield of the Barclays US Corporate High Yield Index was 5.5bps between June 20, 2014 and October 22, 2014 compared with just 2.4bps from the beginning of the year through June 20th.

Context & Perspective:

  • The relative attractiveness of HY to US Treasuries has arguably improved: At 430bps on October 22, 2014, the OAS of the index is 107bps wider than its recent tightest point of 323bps on June 23, 2014.
  • The HY default picture in the US is expected to improve further by year end: Moody's Investor Service reported that the trailing 12-month default rate declined to 1.70% in September from 2.0% in August 2014 and 2.8% a year ago. Moody's sees the default rate at 1.50% by the end of 2014.
  • Globally, the HY default picture is forecasted to rise slightly: Moody's also reported that the global speculative-grade default rate stood at 2.1% in September, the same as August and is forecasting a default rate of 2.3% for December 2014 and 2.6% by September 2015.
  • Supply has exceeded demand recently: Funds experienced net outflows of $4.9 billion in September according to Lipper, increasing net outflows for the year to $13.9 billion. US high-yield primary issuance was strong during the month of September, pricing $38.8 billion.
  • The recent pullback in HY could represent an attractive opportunity: While past performance is no guarantee of future results, the Barclays US Corporate High Yield Index generated a 10.6% total return from 8/23/2013 (the last time its yield was above 6.4%) through June 20, 2014 (when yields bottomed).

Definitions:

The Barclays U.S. Corporate High Yield Index covers the universe of fixed rate, non-investment grade debt, including corporate and non-corporate sectors.

Yield to worst (YTW) is the lowest potential yield that can be received on a bond without the issuer actually defaulting.

A basis point (bps) is one one-hundredth of one percent (1/100% or 0.01%).

An Option-Adjusted Spread (OAS) is a measure of risk that shows credit spreads with adjustments made to neutralize the impact of embedded options. A credit spread is the difference in yield between two different types of fixed income securities with similar maturities.

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

Moody's Investors Service is a leading provider of credit ratings, research, and risk analysis.

Lipper, a Thomson Reuters company, is a global company supplying mutual fund information and fund ratings.


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High yield bonds are subject to increased risk of default and greater volatility due to the lower credit quality of the issues.

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