HIGH YIELD: SPREAD'S THE WORD

Written by: Global Thought Leadership | November 24, 2017

Source: Bloomberg, 11/21/17.  Past performance is no guarantee of future results.  Indexes are un-managed, 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 CHART

The chart shows the average option-adjusted spreads for the Bloomberg Barclays indexes for U.S. Corporate High Yield and U.S. Aggregate Corporate from Nov 21, 2016 to Nov 21, 2017.

THE BOTTOM LINE

• High Yield (HY) bonds have gotten the attention of investors in recent weeks, thanks to a rapid rise of HY spreads – that is, the difference in average yields between HY and similar investment-grade bonds.
• HY spreads can sometimes “blow out” as issuers’ ability to pay deteriorates due to a recession. So the key question is whether this signals a looming problem in general business conditions – or something more benign.
• What’s important to realize is that when considered relative to HY spreads over the past year, current levels aren’t the anomaly; it’s the rest of the year that’s been unusual.   
• The tightening of spreads at the start of 2017 looks more to do with the post-election hopefulness about improving business conditions.
• Indeed, that optimism, which has continued all year, has had a positive impact on perceived creditworthiness at all rating levels. Investment-grade spreads also headed downward for much of the year.
• In fact, the upward moves in both spreads suggests that the explanation for the rise might lie elsewhere. Possibilities include doubts about the outcome of U.S. tax legislation; a surge in issuance of corporate debt in advance of a widely expected rate hike by the Fed in December, driving bond prices down and bringing yields up; and differentiation with in the HY market, as buyers took advantage of new issuance to upgrade the credit profiles of their bond portfolios.
• With an average coupon of 6.4%1 vs 3.9% for U.S. Corporates, the attractiveness of HY is clearly strong.
• In the hands of a discerning active bond manager, able to perform the credit analysis needed to separate the mispriced from the rest in the category, High Yield may clearly be worthy of consideration – especially for income-oriented investors.

1 Source: Bloomberg, Nov 21, 2017

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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