High Yield Market Update

Figure 2: ICE BofA US High Yield Average Dollar Price

Credit Fundamentals

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%

Technicals

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:

• Potential upside equity beta 
• Reduced overall portfolio risk compared to equities 
• Relatively attractive income and lower duration compared to other fixed income alternatives.

Figure 6: US High Yield investor base

SOURCE INFORMATION

“Bloomberg®”, “Bloomberg Indices®”, Bloomberg Fixed Income Indices, Bloomberg Equity Indices and all other Bloomberg indices referenced herein are service marks of Bloomberg Finance L.P. and its affiliates, including Bloomberg Index Services Limited (“BISL”), the administrator of the indices (collectively, “Bloomberg”) and have been licensed for use for certain purposes by MacKay Shields LLC (“MacKay Shields”). Bloomberg is not affiliated with MacKay Shields, and Bloomberg does not approve, endorse, review, or recommend MacKay Shields or any products, funds or services described herein. Bloomberg does not guarantee the timeliness, accurateness, or completeness of any data or information relating to MacKay Shields or any products, funds or services described herein.

ICE Data Indices, LLC (“ICE Data”), is used with permission. ICE® is a registered trademark of ICE Data or its affiliates, and BofA® is a registered trademark of Bank of America Corporation licensed by Bank of America Corporation and its affiliates (“BofA”) and may not be used without BofA’s prior written approval. ICE Data, its affiliates and their respective third-party suppliers disclaim any and all warranties and representations, express and/or implied, including any warranties of merchantability or fitness for a particular purpose or use, including the indices, index data and any data included in, related to, or derived therefrom. Neither ice data, its affiliates nor their respective third-party suppliers shall be subject to any damages or liability with respect to the adequacy, accuracy, timeliness or completeness of the indices or the index data or any component thereof, and the indices and index data and all components thereof are provided on an “as is” basis and your use is at your own risk. ICE Data, its affiliates and their respective third-party suppliers do not sponsor, endorse, or recommend MacKay Shields LLC, or any of its products or services.

NOTE TO EUROPEAN INVESTORS

This document is intended for the use of professional and qualifying investors (as defined in the Alternative Investment Fund Manager’s Directive) only. Where applicable, this document has been issued by MacKay Shields Europe Investment Management Limited, Hamilton House, 28 Fitzwilliam Place, Dublin 2 Ireland, which is authorized and regulated by the Central Bank of Ireland.

IMPORTANT DISCLOSURE

Availability of this document and products and services provided by MacKay Shields LLC may be limited by applicable laws and regulations in certain jurisdictions and this document is provided only for persons to whom this document and the products and services of MacKay Shields LLC may otherwise lawfully be issued or made available. None of the products and services provided by MacKay Shields LLC are offered to any person in any jurisdiction where such offering would be contrary to local law or regulation. This document is provided for information purposes only. It does not constitute investment or tax advice and should not be construed as an offer to buy securities. The contents of this document have not been reviewed by any regulatory authority in any jurisdiction. This material contains the opinions of certain professionals at MacKay Shields but not necessarily those of MacKay Shields LLC. The opinions expressed herein are subject to change without notice. This material is distributed for informational purposes only. Forecasts, estimates, and opinions contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. Any forward-looking statements speak only as of the date they are made and MacKay Shields assumes no duty and does not undertake to update forward-looking statements. No part of this document may be reproduced in any form, or referred to in any other publication, without express written permission of MacKay Shields LLC. ©2022, MacKay Shields LLC. All Rights Reserved.

Information included herein should not be considered predicative of future transactions or commitments made by MacKay Shields LLC nor as an indication of current or future profitability. There is no assurance investment objectives will be met. Past performance is not indicative of future results.

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.