US high yield’s hot streak continued. The ICE BofA US High Yield Index’s 1.6% September return marked its fifth consecutive month of gains. Since November 2023, the high yield index has returned 17.1% (with only April 2024 showing a monthly loss). This represents the index’s best eleven-month performance period since the 2020–21 V-shaped recovery following the COVID selloff.
The recent performance of CCC bonds is unprecedented in a “non-stressed” market environment. Historically, the strongest CCC returns—both relative and absolute—have followed periods of market stress, when the broad high yield market has bottomed and is in its early stages of recovery. In other words, when CCC-rated bonds rally significantly, the starting spread of the broad high yield market has always been wide.
Specifically, distressed high yield bonds have been the real winners. After languishing in the first half of 2024, the ICE BofA US Distressed High Yield Index—a subset of the US High Yield Index comprised of bonds with more than 1,000bps OAS—soared 20.6% in Q3, including a 9.1% gain in September alone.
In our view, the recovery in distressed issuers has been warranted in some cases due to an improvement in credit fundamentals, such as M&A or asset sale announcements. More often, however, we see soaring distressed bond prices simply as a reflection of excessive optimism on credit risk.
Demand for leveraged credit has overwhelmed the supply of high yield bonds, as evidenced by strong retail fund flows. However, the real demand has come from institutional investors. Anecdotally, they are turning to high yield to generate total returns without the increased volatility associated with U.S. equities, which trade near all-time highs. Institutions are also allocating to high yield through multi-sector and multi-asset strategies. Private credit funds flush with cash and “pods” of large hedge funds have also piled in.
There are simply not enough new high yield bonds to meet this demand. While new issue activity has rebounded – $250 billion of high yield bonds have been issued so far in 2024, compared to $106.5 billion and $176.1 billion in 2022 and 2023, respectively – 78% of the proceeds have been used to refinance existing high yield bonds. Moreover, new supply this year is still approximately 38% below the average volumes between 2019 and 2021 (Source: JP Morgan). Net new supply remains constrained due to a sluggish rebound in corporate M&A activity, a lack of "fallen angels" from the investment-grade sector, and muted LBO activity from private equity sponsors. Private credit has also played a role, as it competes to lend to companies that would normally borrow from the leveraged loan and, to a lesser extent, the high yield markets.
Valuations reflect these near-perfect conditions. As of September 30, the ICE BofA US High Yield Index spread-to-worst of 330 basis points is lower than the 20-year median of 453 basis points and sits at the lower end of the post-GFC "non-panic" range of 325-525 basis points, as illustrated below:
Figure 1: Spread to Worst
Index: ICE BofA US High Yield Index
As of September 30, 2024
Source: ICE Data
There are many risks in financial markets today. However, we maintain that stable fundamentals and reasonable valuations suggest that US high yield continues to represent a reasonable, lower duration fixed income investment option.
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High yield securities have speculative characteristics and present a greater risk of loss than higher quality debt securities. These securities can also be subject to greater price volatility.
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CREDIT RATING DISCLOSURES (FOR INDEX)
ICE BofA Credit Ratings
ICE BofA utilizes its own composite scale, similar to those of Moody’s, S&P and Fitch, when publishing a composite rating on an index constituent (eg. BBB3, BBB2, BBB1). Index constituent composite ratings are the simple averages of numerical equivalent values of the ratings from Moody’s, S&P and Fitch. If only two of the designated agencies rate a bond, the composite rating is based on an average of the two. Likewise, if only one of the designated agencies rates a bond, the composite rating is based on that one rating.
COMPARISONS TO AN INDEX
Comparisons to a financial index are provided for illustrative purposes only. Comparisons to an index are subject to limitations because portfolio holdings, volatility and other portfolio characteristics may differ materially from the index. Unlike an index, individual portfolios are actively managed and may also include derivatives. There is no guarantee that any of the securities in an index are contained in any managed portfolio. The performance of an index may assume reinvestment of dividends and income, or follow other index-specific methodologies and criteria, but does not reflect the impact of fees, applicable taxes or trading costs which, unlike an index, may reduce the returns of a managed portfolio. Investors cannot invest in an index. Because of these differences, the performance of an index should not be relied upon as an accurate measure of comparison.
The following indices may be referred to in this document:
ICE BofA US High Yield Index
The ICE BofA US High Yield Index tracks the performance of U.S. dollar denominated below investment grade corporate debt publicly issued in the U.S. domestic market. The ICE BofA US High Yield Index tracks the performance of U.S. dollar denominated below investment grade corporate debt publicly issued in the U.S. domestic market. Qualifying securities must have a below investment grade rating (based on an average of Moody’s, S&P and Fitch) and an investment grade rated country of risk (based on an average of Moody’s, S&P and Fitch foreign currency long term sovereign debt ratings). In addition, qualifying securities must have at least one year remaining term to final maturity, a fixed coupon schedule and a minimum amount outstanding of $100 million. Original issue zero coupon bonds, "global" securities (debt issued simultaneously in the Eurobond and U. S. domestic bond markets), 144a securities and pay-in-kind securities, including toggle notes, qualify for inclusion in the Index. Callable perpetual securities qualify provided they are at least one year from the first call date. Fixed-to-floating rate securities also qualify provided they are callable within the fixed rate period and are at least one year from the last call prior to the date the bond transitions from a fixed to a floating rate security. DRD-eligible and defaulted securities are excluded from the Index.
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