High Yield Daily Update

The Bloomberg Barclays US High Yield Index was up 0.07% on Friday,* while it is a muted start to the week in the high yield bond market as we have the Russia/US meeting happening and many have a sports hangover.  It was a big day for sports outside of the US, with the Wimbledon finals, the World Cup Championship, and the Le Tour de France racing across the famed cobblestones.  Equity markets are opening flat today, mirroring high yield, which is holding up relatively well despite oil down $1.75.  Oil is down on headlines that the Saudis are taking president Trump’s suggestion to pump a little more and his treats of releasing oil from the US reserves to keep oil and gasoline prices down.  Many believe this will be temporary and from what I read many expect $80 oil this year.  Retail sales for June outside of autos and fuel were not overheated but the story here were the big revisions upward from May.  Tax cuts and tax refunds seems to be putting confidence in the consumer.

Lipper reported inflows of +$1.85 billion into high yield bond mutual and exchange traded funds, while floating rate bank loan mutual and exchange traded funds had a +$212 million inflow for the week ending 7-11-18. Fund flows into bonds were flat on Friday, while loans continue to see inflows.  The technicals for high yield have been a very interesting and confusing mixed bag.  Outflows from high yield mutual funds and ETFs have been huge both in 2017 and so far in 2018, so that creates a significant headwind.  But real money investors have been playing a bigger role and they remain strong.  People often forget about how much coupon cash flow and proceeds from calls, maturities, and tenders comes in weekly that needs to be re-invested.  The supply side has been considerably below last year, which has been a significant positive offsetting the fund out flows.  So overall, high yield market technicals are neutral.  We would expect new issue supply in bondland for 2018 to be well below what we saw last year.

There have been a ton of investors throwing cash at the floating rate loan market this year.  We think one of the biggest problems this cycle will be the collateralized loan obligations (CLOs).  While we see many attractive opportunities in the off the run loan market (which we view as a less efficient market, with more “orphaned” credits that aren’t widely followed), loans overall have been very popular and are sporting far more leverage than in past cycles.  The value of having a first lien in a 5-6x levered company may not be worth that much if it is the only debt outstanding, and for those credits that are impaired, the recovery rates may be well below historical averages.  So this potentially may be a far bigger mess down the road, and may create even more opportunity once it begins to unravel.  We see much “research” discussing moving senior into loans but that is a misnomer in many cases.  Tourists in that asset class need to be aware.  Loans are simply another great opportunity set; there are lots of good ones and lots of bad ones.

There is the constant question of active versus passive management.  This is the time in the cycle where asset class runs have been spent.  We have often said that as an active manager, we don’t see our position in as managing money, but rather managing risk.  We believe this is absolutely critical going forward.  We believe that investors should avoid many of the deeply subordinated and highly levered transactions, thus actively managing risk is crucial.  The large high yield index-tracking ETFs have seen heavy inflows over the past couple weeks, but investors should look into the yields and returns many of these funds have generated so far this year—they might not like what they see.  We believe that active management is better positioned for the current environment on both the yield generation and risk side.

* Bloomberg Barclays U.S. Corporate High Yield Index covers the universe of fixed rate, non-investment grade debt (source Barclays Capital).
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