U.S. high-yield bonds: Spread's the word

Written by: Global Thought Leadership | August 04, 2017
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Source: Bloomberg, as of August 2, 2017. 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

  • As high yield U.S. corporate bond spreads tightened from the peak levels that prevailed in February 2016, the asset class has generated solid returns.
  • In fact, since the spread’s peak value on February 9 of that year, the Barclays U.S. Corporate High Yield Bond Index generated a cumulative total return of 30.03% through August 2,2017.
  • Over that same period, the option-adjusted spread (OAS) of the index tightened by just over 470 basis points (bps) from 820 bps to 349 bps.
  • Behind the elevated spreads in February 2016: credit markets reflected the then-prevailing expectations of a global recession.
  • As those fears subsided, spreads tightened rapidly throughout the remainder of the year and have continued to do so this year.
  • At 349 bps as of August 2, 2017, the option-adjusted spread is near its lowest point since the end of the 2007-8 Global Financial Crisis (323 bps).
  • On the one hand, this level suggests that financial markets are quite optimistic about economic fundamentals and corporate balance sheets—an environment of moderate growth, low inflation and central bank caution has been a strongly favorable backdrop for the sector.
  • On the other hand, the latest tightening means that current investment opportunities are very issue-specific— because general spread compression within the asset class is more unlikely when spreads are already tight. 
  • In that kind of environment, simply buying the asset class via a passive investment strategy could expose an investor to some significantly overpriced sectors.
  • However, active managers that base investment decisions on the merits of specific issuers and the characteristics of individual securities have the flexibility to initiate positions only in those credits where valuations may be most attractive.
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