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High time for high-yield, the US equity substitute?

Those who believe that ‘risk-on, risk-off’ is consigned to the past look away now, with record inflows into US high-yield indicating that sentiment has shifted once again to the spicier end of the fixed income spectrum.



Data released this week by Lipper shows inflows into US high-yield bonds totalled nearly $5bn in the week that ended 2 March – the largest figure on record.

This ties in with what UK wealth managers have been saying about a risk-on move back into open-ended high-yield funds.

High yield has been under pressure since mid-2014, and with investors in the asset class having found it tough going during the past 18 months. 

According to Marino Valensise, head of Barings’ multi-asset group, as the price of oil has fallen, high-yield bonds have been hit by the deteriorating creditworthiness of energy issuers and, as a result, bonds issued by companies operating in different economic sectors have also been under pressure.

He says: “With the most negative projections already factored in, a yield to maturity of 10% from high yield is attractive. It allows for a certain margin of error in the event of a further deterioration in credit conditions.  Investors with a time horizon of 18-24 months should be well rewarded.”

A stat worth noting is that the preeminent US high-yield bond index (US High Yield Master II Constrained) has never in fact experienced two consecutive annual declines in its multi-decade history.

The global high-yield market is dominated by the US: as of the end of January, $1.3tn worth of US debt was in issue versus €308bn in European assets.

From a fund manager point of view, Thomas O’Reilly of Neuberger Berman’s High Yield Bond Fund, points out that just 20% of the US market is in the challenged energy and commodity-related sectors.

He explains: “High-yield valuations, excluding the commodity areas, are compensating investors for default risk. The yield-to-worst for the overall high yield market is 9.1% – but it is 7.6% excluding energy and commodities, still a spread of 648 basis points.

“The default rate was 1.8% last year and has been under 3% for six years, but this could approach 6% in 2016 and 2017. But again, it will likely be concentrated in the energy and commodity spaces. We do not expect a significant uptick in defaults in the other areas of the market.”