As I read the morning news from many, many different sources as I do every morning all I hear lately is “Is This the End for High Yield?” but what does that mean? The end meaning Madoff, Bear Stearns or the structured vehicles (mortgages) that all blew up during the financial crisis? We certainly don’t see any of these systemic issues on the horizon.
So how should investors look at the high yield market today? You need to first look at the overall economy and the health of corporate American, and then look to the industry and health of the company you are loaning money to, whether it be in the form of a bond or loan. The high yield market is made up of companies, many of which provide essential products and services to all of us. When there is an end to a high yield issuer it is often because the management has mismanaged their capital structure or their product or service is no longer in demand as it once was (competition or a new buggy whip replaced it).
In the current high yield market you have expensive prices on many securities, but we don’t see a broad based credit crisis emerging. You have had money flowing into a variety of yield products because investors often want to be diversified into different asset classes. The good and the bad of managing yield products is that money flowing in has driven up prices and thus created nice returns, but have also made many securities overvalued to their call or maturity prices or to the credit metrics, and thus they understandably correct at some point. We believe investors need to understand that new-issue are being brought to the market each day to refinance existing debt, and this refinancing can be done at a call price which may well be below the trading pricing of the security prior to the refinancing announcement. Thus understanding the call schedule or the ability to evaluate the prospects of a bond being tendered at a price above the call/maturity price is important. This sort of strategic investing involves active, not passive management.
As an active manager, Peritus targets an above index coupon and yield-to-worst with their strategy and the potential for alpha generation for investors. Yes, index/passive investing might be less expensive, but we believe that you get what you pay for over time. We believe that being in the right credits is important. But we also believe that being invested is important as perfectly timing the market can be difficult. If you are someone that has an expertise in timing the market, good luck as I believe it has been proven that over time the returns are less because following a correction, the snap back can be faster than the market timers emotions allow them to step back in—so they could miss the move.
Turning to the specifics for the market today, we see the high yield market lower again this morning along with equities and oil, as the money looks to be going into longer Treasuries with the 10-year down to 2.34% from 2.4% just a few days ago. Oil is lower as there is a report that US shale will be equal in size to the Saudi’s in a few years and the IEA reporting a less bullish demand growth outlook for 2018, along with the API reporting a build in oil inventories rather than a draw down as had been expected.
Even with some pricing weakness and outflows, there were seven new-issues that priced yesterday in the high yield bond market totaling $4B. There are ten new-issues on the forward calendar, so this does not look like an end to high yield. Rather to us, it looks like an opportunity to add to your positions. We are seeing some of the strategists at the banks come out with expectations that investors will to continue to seek exposure to high yield and suggests that riskier segments of the market have seen tighter risk premiums around similar points in the credit cycle in the past.