The high yield bond market has seen a decent start to the first half of the year, with the Bloomberg Barclays High Yield Index up 4.93% through June.1 However, as we near almost a decade in this low interest rate environment, many investors are becoming concerned about the yields and rate of return available in today’s high yield market. While high yield bonds are not routinely carrying high single digit to double digit coupons like they did years ago, the comparable 10-year Treasury yield is also not above 5% as it was back then.
Looking back at the historical data for the high yield market, high yield spreads are below historical averages and medians, but this makes sense given the below average default outlook, as we have noted in recent writings (see our commentary, “Mid-Year High Yield Bond Market Default Review and Outlook”). And while spreads are below these average and median levels, they are well off historical lows. Additionally, the premium to the 10-year Treasury is currently above the historical averages and medians, offering a 193% premium to the 10-year versus a historical average of 172% and median 148%.2
We have seen the high yield market mature over the past decade. Arguably outside of certain energy deals, we are seeing more of the aggressive financing being done in places like middle market lending rather than via high yield debt. So while the current coupon levels, and likely corresponding near-term return expectations, are not as high as they have historically been, we still see value in today’s high yield market, especially in the context of the broader financial environment.
We don’t expect that interest rates are going to take off. Demand is a driver of growth and we don’t see demand for much of anything. The global population is aging and labor rates will undoubtedly be impacted by this as well as technology, innovation and other social and behavioral changes we are in the midst of, be it electronic vehicles, the decline of brick and motor retail outlets, and the shared economy. With little to drive growth, we don’t see a demand for money or inflation to move rates significantly higher. The 5-year and 10-year Treasury yields are indicating that there isn’t much in the way of pressure on rates and or a strong demand for money. Additionally, with all of the post financial crisis regulation, we do not see any systemic issues on the horizon. Considering both of these factors, it makes sense that risk premiums are generally where they are.
Yes, we do see some securities within the high yield market that offer too low of a yield relative to the risk—be it aggressive leverage levels relative to the yield offered, or a security trading at a premium offering a very low yield to worst to investors, as many names are in the 3-5% yield range—but as active managers, we don’t have to invest in these securities. Within today’s high yield bond and loan market we believe our active strategy makes sense and offers investors value from both a yield and duration perspective versus the indexes and many index-based products.
1 Bloomberg Barclays US High Yield Index covers the universe of fixed rate, non-investment grade debt, data from Barclays Capital for 12/31/16-6/30/17.
2 Jantzen, Nelson, CFA and Peter Acciavatti, “JPM High-Yield and Leverage Loan Morning Intelligence,” J.P. Morgan North American Credit Research, 5/16/17 and 6/30/17, https://markets.jpmorgan.com.