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Todd Youngberg, Global Investment Director – Fixed Income and Head of High Yield
Investments at Aviva Investors, provides his views on the outlook for high yield bonds and the
opportunities that the asset class has to offer.
“The global high yield bond market has made off to a good start in 2011, with returns of
approximately 3.2%[[Data according to Bank of America Merrill Lynch]] through mid-March. High yield bonds have been resilient during the recent
equity volatility. Demand for high yield bonds has been strong, with mutual fund inflows of US$9
billion, or 4.6% of fund assets, year to date, according to AMG Data Services. We are also seeing
even larger demand for leveraged loan funds in anticipation of hedging inflation risks due to their
floating rate structure.”
“That said, the yields in high yield bonds are near all time lows at just over 7%[[Data according to Bank of America Merrill Lynch]], and we therefore reiterate return forecasts of 7% to 8% for high yield bonds and 6% to 7% for leveraged loans for 2011. These remain attractive rates of return when compared to investment grade fixed income alternatives.”
“While yields are low on a historical basis in the high yield market, we are seeing opportunities to
increase total return by finding bonds with the potential to ‘cross-over’ into the investment grade
universe. Upgraded bonds become open to a larger universe of buyers and typically have price
appreciation as their risk premium, or spread, narrows. For example, a BB+ rated bond such as
Macy’s, the department store, trades with roughly a 5%[[Data sourced from Bloomberg]] yield, however a potential return would be closer to 9% if the bond is upgraded to investment grade as its spread tightens.”
A number of key market indicators support a marketweight allocation to high yield bonds and
leveraged loans:
1. Global default rate is low and expected to fall further: The probability of default has been
lessened by firms’ extensions of maturities at attractive rates, large cash balances, improved
operating leverage and higher profit margins.
2. Low real rates supporting narrow high yield spreads: A low real rate environment has
been accommodative for the high yield market, helping provide a low cost of capital for
refinancing and extending maturities.
3. Credit rating trends most favourable since 1998: Strengthened corporate balance sheets
and robust earnings support a credit rating upgrade environment and the trailing 12-month
downgrade/upgrade ratio is near an all time low.
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