21 Jun 2023
For years, investors have faced the reality of lending to corporates at ever falling yields. Now, the high yield market is living up to its name. As rates have shifted higher, yields on high yield bonds continue to increase, even in the higher-quality part of the market.
Prior to 2022, persistently low rates left investors facing dismal yields in fixed income. Despite low yields for investors, this cheap financing has been supportive for company fundamentals. For one, this lower interest expense has helped keep defaults relatively low. However, you don’t earn a return on a default count, nor do you earn return on excess spread. High yield is a total return asset class where income is key. That income accrual for high yield investors is starting to rise rapidly as we’re in an environment where issuers are forced to borrow at very high funding rates.
Take the BB part of the market. Over the last couple years, yields have risen significantly for the BB part of the ICE BofA Global High Yield index (Exhibit 1). In fact, the current funding rates for newly issued bonds are even higher than the chart suggests as the index yield includes many short-dated bonds that don’t earn all that much more than risk free. For new, long dated funding the reality is painful for companies as they face higher financing costs. Meanwhile, higher coupons are great for creditors and investors like ourselves.
In this environment, we are finding attractive opportunities to add exposure to higher-quality companies within the BB segment that offer high coupons and compelling long-term total return potential. Take some recent examples of bonds for public BB rated companies that we have added to the portfolio and their associated coupons. Examples include: Electricite de France (9.125%), Royal Caribbean (8.25%), XPO Logistics (7.125%), Charter Communications (7.375%), Ford (7.2%), among others. Even the likes of BT Group are in the market this week and printing an 8.5% piece of paper, which is an attractive level for a high-quality communications company.
In short, we believe it’s a great time to be a high yield bond investor. You don’t need to chase lower-rated or CCC risk to earn large returns anymore. In fact, our portfolio has been moving out of this part of the market and up in quality for partly this reason. We view it as a clear transfer of wealth from equity to bond holders. While dividends are optional, paying interest on corporate debt isn’t.
If we stay in a higher-for-longer environment, we are quite happy to keep lending to companies at these levels. At some point, yields will fall again, but for now, the ball is back in the high yield market’s court, providing investors with attractive income and total return opportunities.
Exhibit 1: Global High Yield Index – BB Yield to Worst
Source: Bloomberg. Based on the BB segment of the ICE BofA Global High Yield Index. Includes data from 4 January 2021 to 13 June 2023.
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