The Advantage of Quality High Yield in Today’s Market
The Advantage of Quality High Yield in Today’s Market
The high yield (HY) market has outperformed other fixed income sectors so far this year, generating positive returns despite rising interest rates. However, several factors—including an uptick in default rates, a higher cost of capital, and the possibility for volatility going forward—suggest to us that the higher quality BB segment is the optimal area within high yield, providing yield and more defensive portfolio positioning.
Troy Johnson, CFA, Director of Fixed Income Research, and Greg Shea, CFA , Senior Portfolio Manager , provide an in-depth analysis of the high yield market, discussing how different rating categories have fared and the ability of quality high yield to withstand volatility going forward.
Key Takeaways
- Lower quality CCCs have led performance this year, outperforming the quality part of the market. However, defaults are rising while spreads are declining, suggesting potential volatility for riskier segments of the market going forward.
- High-yield market leverage is healthy overall with net leverage at 3.6x and interest coverage at 4.8x. However, lower-rated CCC companies remain highly leveraged with low coverage, leaving them vulnerable to rising rates and refinancing challenges.
- BBs, the higher quality part of high yield, have offered the best risk/reward over long-term horizons. Our analysis shows BBs consistently outperform broader high yield, assuming a $1 million investment and 5% withdrawal rate.
Additional Resources:
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