Figure 2: ICE BofA US High Yield Average Dollar Price
Credit trends have weakened somewhat. First quarter earnings from high yield issuers are showing the effects of cost inflation, strained supply chains, and scarce raw materials.
Cost inflation in Europe is particularly concerning. Even though most US high yield issuers are focused domestically (88% are located in the US), others have manufacturing operations in Europe that are experiencing severe cost shocks; for example, natural gas is almost 7x higher in Europe than the US.
The broader credit risk profile of the US high yield market continues to remain strong. The largest high yield issuers are generally large publicly traded companies; S&P 500 companies represent 25% percent of the ICE BofA US High Yield Index. The credit quality of the US high yield market continued to improve in 2021, with 58% of new issues rated BB. The ICE BofA US High Yield Index is now comprised of 54% BBs (on a par value basis), up from 43% at the end of 2011.
Default rates remain subdued in this environment given better long-term credit fundamentals. As seen in Figure 4, right, the US high yield default rate over the last twelve months has decreased to just 0.5% versus a long-term average of about 3%.
Figure 3: US High Yield has Trended Towards Higher Quality, Public Companies
BB-Rated Credits have Increased as a Proportion of the US High Yield Market, Alongside a Decrease in CCC-Bonds: 25% of the US High Yield Index is Now Comprised of Companies in the S&P 500 Index
Figure 4: US High Yield Par Weighted Default Rate
Rising Rate Performance
From an interest rate perspective, we believe US high yield is better positioned than most fixed income asset classes to withstand a sharp rise in rates due to its higher coupons and shorter durations. Credit (rather than interest rates) has historically been the more important risk for high yield, and the market has been resilient during previous rising interest rate environments because of the correlation between rising rates and economic growth. However, today’s high yield market is more vulnerable than it has been historically. As the overall credit quality has improved, coupons have shrunk.
Figure 5 below highlights the US High Yield Index’s return in periods during which the 10-Year US Treasury rose more than 100bps since 2000 compared to other fixed income alternatives.
Figure 5: Periods Since 2000 - 10-Year US Treasury Yield Increases More Than 1%
Market weakness has caused retail outflows in 2022. Despite heavy retail outflows, the underlying demand for US high yield market has remained stable. Since the start of 2022, the combined assets of the two largest high yield ETFs – the iShares iBoxx High Yield Corporate Bond ETF (HYG) and the SPDR Bloomberg High Yield Bond ETF (JNK) – have plunged 35% from $31bn to $20bn. However, ETFs only represent 4% of the high yield investor base. As shown in the chart below, US high yield is largely held by long-term, unleveraged investors such as pension plans, insurance companies, and foreign institutional buyers. Generally in the past, investors have looked to reduce risk in their overall portfolio by selling equities to fund their US high yield investments as US high yield can provide:
Figure 6: US High Yield investor base
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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:
BLOOMBERG GLOBAL AGGREGATE INDEX ― The Bloomberg Global Aggregate Index is a flagship measure of global investment grade debt from twenty-four local currency markets. This multi-currency benchmark includes treasury, government-related, corporate and securitized fixed-rate bonds from both developed and emerging markets issuers.
BLOOMBERG US GOVERNMENT 10 YEAR TOTAL RETURN INDEX ─ The Bloomberg US Government 10-Year Total Return Index is a wealth series that starts on January 1, 1999, based on holding US 10yr treasuries (see last chart – showing the complete wealth series to date); calculated in USD; unhedged and rebalanced monthly.
CREDIT SUISSE LEVERAGED LOAN INDEX ―The Credit Suisse Leveraged Loan Index s a representative index of tradable, senior secured, U.S. dollar-denominated noninvestment grade loans.
ICE BOFA CORPORATES CASH PAY BB-B 1-5 YEAR INDEX ─ A subset of the ICE BofA U.S. Cash Pay High Yield Index including all securities with a remaining term to final maturity less than 5 years and rated BB1 through B3 inclusive. Index results assume the reinvestment of all capital gain and dividend distributions. An investment cannot be made directly into an index.
ICE BOFA US CORPORATE INDEX ─ ICE BofA U.S. Corporate Index tracks the performance of U.S. dollar denominated investment grade corporate debt publicly issued in the U.S. domestic market.
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 i
ICE BOFA US EMERGING MARKETS EXTERNAL DEBT SOVEREIGN & CORPORATE PLUS INDEX ―The ICE BofA Emerging Markets Corporate Plus Index tracks the performance of US dollar (USD) and Euro denominated emerging markets non-sovereign debt publicly issued within the major domestic and Eurobond markets. ssued 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. DRDeligible and defaulted securities are excluded from the Index.
J.P. MORGAN EMBI GLOBAL DIVERSIFIED INDEX The J.P. Morgan ESG EMBI Global Diversified Index (JESG EMBIG) tracks liquid, US Dollar emerging market fixed and floating-rate debt instruments issued by sovereign and quasi-sovereign entities.