Investment Options in Corporate Debt

Fixed income is an important component of a balanced portfolio.  The problem many investors and advisors face today is where do you find yield in this environment and what happens to your fixed income exposures should rates rise?  Where can you go in the fixed income sector?

A traditional balanced portfolio often includes some sort of corporate bond component, and often the focus is on investment grade bonds.  However, we believe that investors should additionally consider high yield corporate debt as part of their corporate fixed income component.  Even accounting for the traditionally higher default risk, high yield bonds have outperformed investment grade bonds over the past twenty five years.1

25-yr HY, IG return2

While defaults are a consideration when evaluating the corporate bond space, the forward default outlook for the next several years shows projected defaults to be well below average, indicating a more benign default environment for high yield bonds as we look forward.2

JPM Default Forecast 2-3-17

We would see a generally positive fundamental environment for corporate credit on this front.

On the interest rate front, investment grade bonds carry a much longer maturity and lower yield, in turn making their duration (a measure of interest rate sensitivity) much longer, at about 4 years for high yield bonds versus 7.3 years for investment grade.3

HY, IG stats 1-31-17

The vast majority of high yield bonds are issued with maturities ranging from 5-10 years, while investment grade bonds often have maturities well beyond that range.  This puts the average maturity of the high yield index at just over 6 years while the average maturity on the investment grade index is 4.5 years longer, closer to 11 years.

Additionally, investment grade returns historically have been very negatively correlated with changes in Treasury yields, while high yield bonds have been positively correlated.4

Correlation chart 1-31-17

This means that if your concern is rates will rise, which in turn will cause the yield on government bonds (5- and 10-year Treasuries) to increase, then historically, returns on investment grade bonds have decreased, thus the negative correlation.  On the flip side, the positive correlation between high yield and Treasuries would indicate that as yields increase in Treasuries, we have historically seen positive returns in high yield bonds.  The historical data shows that high yield bonds have actually performed well in periods of rising rates (see our writings “Strategies for Investing in a Rising Rate Environment” and “The Election Impact on the High Yield Market: Rates and Regulation”).

As we look at the fixed income sector, we believe that high yield bonds are a viable investment choice in today’s market relative to investment grade bonds.  Investment grade debt carries a much longer maturity and a much higher duration, meaning more interest rate risk should we see rates rise.  In addition, the coupon income and yield is much higher for high yield bonds, as indicted by the charts above.   Those looking for some yield generation for their fixed income debt allocation and less interest rate exposure should take a look a high yield corporate debt.

1  Bloomberg Barclays Capital U.S. High Yield Index covers the universe of fixed rate, non-investment grade debt (source Barclays Capital). Bloomberg Barclays US Corporate Investment Grade Index consists of publicly issued U.S. corporate and specified foreign debentures and secured notes that meet the specified maturity, liquidity, and the quality requirements (source Barclays Capital).  Returns cover the period of 1/31/1992 to 1/31/2017.
2  Jantzen, Nelson, CFA and Peter Acciavatti, “JPM High-Yield and Leveraged Loan Morning Intelligence,” J.P. Morgan North American Credit Research, February 3, 2017.
3  Bloomberg Barclays Capital U.S. High Yield Index covers the universe of fixed rate, non-investment grade debt (source Barclays Capital). Bloomberg Barclays US Corporate Investment Grade Index consists of publicly issued U.S. corporate and specified foreign debentures and secured notes that meet the specified maturity, liquidity, and the quality requirements (source Barclays Capital.  Data as of 1/31/17. Yield to Worst is the lowest, or worst, yield of the yield to various call dates or maturity date. Duration is the change of a fixed income security that will result from a 1% change in interest rate, using modified adjusted duration.
4  Bloomberg Barclays Capital U.S. High Yield Index covers the universe of fixed rate, non-investment grade debt (source Barclays Capital). Bloomberg Barclays US Corporate Investment Grade Index consists of publicly issued U.S. corporate and specified foreign debentures and secured notes that meet the specified maturity, liquidity, and the quality requirements (source Barclays Capital).  Returns cover the period of 1/31/1992 to 1/31/2017.  5-yr and 10-yr US Treasury percentage change in yield is for the period 1/31/1992 to 1/31/2017, with data sourced from Bloomberg.  Correlation performed based on monthly returns for HY and IG index and monthly yield changes for the US Treasuries.
Posted in Peritus

Pricing Risk and Playing Defense

Since the election, we have watched equity markets soar, bond yields rise dramatically and animal spirits returning to life.  Is this the beginning of new trends or the beginning of the end of the rallies that began in 2009?  The reality is that none of us know the future.  What we do know is that the two monsters of debt and demographics remain in the room and nobody is going to change their impacts.  And they have a far bigger impact than much of the optical engineering we are now witnessing with Trump-O-Nomics.  The equation we are dealing with is debt + demographics = no demand.

As we look toward 2017, we believe volatility will return to markets and what you don’t own will be as important as what you do.  It is time to play good defense and we will do just that while also capitalizing on the select value-based opportunities within today’s high yield market.  Click here to read our most recent market commentary, “Pricing Risk and Playing Defense,” in which we discuss our market outlook and corresponding investment strategy.

Posted in Peritus

Managing Volatility

As we have talked with advisors and investors over the past couple years, we often hear the topics of yield and volatility mentioned.  Investors are looking for yield and income generation, especially in the persistently low yield environment we’ve seen for years now, but they also don’t want to go out on a limb in terms of volatility, as they want to protect their or their clients’ money.  Caution seems to be the investment mindset of choice these days.

We have heard these calls for lower volatility and over the past year have worked to dampen the volatility within our own strategy.  Below are some of the actions that we have taken along this effort:

  • Increasing the number of positions: While we certainly don’t want to take the “one-of-everything” strategy that seems to be employed by many index-based and other large funds that hold hundreds and even over a thousand securities, we have expanded our number of holdings.  The law of diminishing returns comes into play as you get to a certain number of holdings; thus we don’t see holding hundreds of securities as to your advantage.  Rather we want to hold the right securities; enough diversification to work to lower security specific risk and volatility while still staying true to our active strategy.
  • Monitoring Position Sizes: Holding a broad number of individual securities alone isn’t enough.  We also continually monitor our position sizes.  For instance, with the big run up in certain of our holdings in 2016, we saw some of these securities become overweights within our portfolio.  Thus, as we see fit, we have and will continue to work to trim back position sizes to levels we see as appropriate.
  • New Issue Allocation: As we have spoken about on numerous occasions, we have implemented a strategy enhancement of allocating a certain portion of our portfolio to newly issued bonds.  Our experience has been that these bonds tend to be well vetted prior to issuance, which can help minimize the unfavorable surprises in the weeks and months following issuance—meaning less potential downside volatility.  Additionally, our experience has been, and market research indicates, that bonds tend to be more liquid immediately following issuance, which may also serve to help managed liquidity.
  • New Issue Sell Disciple: Part of the new issue strategy involves continually rolling out of prior new issue holdings into more recently issued bonds.  By and large our experience over the last year has been that we are selling these holdings at premiums to issuance price, allowing for potential capital gains.  However, we have implemented a tight sell discipline on downward price movements, which we believe will allow us to better protect on any potential downside, further enhancing the volatility focus of this portion of the portfolio.

As we look toward 2017, we believe that active management and the ability to manage downside volatility will be all the more important for investors across the broad spectrum of asset classes, including high yield: we expect that in 2017 what you own and, importantly, what you don’t own will matter.  We have decades of experience in actively managing high yield portfolios.  Our end goal has been and will continue to be to generate alpha for our investors.  We believe the skill set we have acquired over these years in managing high yield debt allows us to continue with that goal of alpha generation all the while working to manage downside volatility with recent actions taken.

Although information and analysis contained herein has been obtained from sources Peritus I Asset Management, LLC believes to be reliable, its accuracy and completeness cannot be guaranteed. This report is for informational purposes only. Any recommendation made in this report may not be suitable for all investors. As with all investments, investing in high yield corporate bonds and loans and other fixed income, equity, and fund securities involves various risks and uncertainties, as well as the potential for loss. High yield bonds are lower rated bonds and involve a greater degree of risk versus investment grade bonds in return for the higher yield potential. As such, securities rated below investment grade generally entail greater credit, market, issuer, and liquidity risk than investment grade securities. Interest rate risk may also occur when interest rates rise. Past performance is not an indication or guarantee of future results. Actual results may vary depending on market conditions, among other factors. The index returns and other statistics are provided for purposes of comparison and information, however an investment cannot be made in an index.
Posted in Peritus

High Yield Bonds for Income and Total Return Potential

Asset allocation is a delicate balance for any investor, but it has been complicated by certain factors within the current financial environment, including high equity valuations, the potential for higher interest rates, and the need for some yield in a continued low yield environment.  Whether you are in a phase of life where income generation is key or you are putting together a portfolio more focused on generating a total return, we believe there could be a place for high yield bonds within a portfolio.

First let’s look at the high yield bond market from a historical returns perspective.  Looking over the past 25 years, we have seen high yield bonds outperform a variety of fixed income categories.1

25yr return 12-31-16

This performance covers a variety of market environments and cycles.  While equities have performed slightly higher on a pure return basis, let’s drill that down in terms of the relative risk.  Below, we look at the risk adjusted return (return/risk) for equities versus high yield bonds, using the volatility (standard deviation of returns) as our measure of risk.2

Risk-return 25 yr 12-31-17

Over the last quarter century, the high yield market has experienced significantly less volatility than equities, as represented by the S&P 500 Index, putting the high yield bond market’s return per unit of risk (return/risk) about 50% higher than the return/risk for the equity index.  And we are not just capturing upside volatility, as the high yield bond index’s highest calendar year is much higher than that of the equity index, while the lowest year also fared better for high yield than equities.

We see high yield bonds as a very attractive and viable alternative to complement an equity portfolio.  For the more total return-focused investors, much of fixed income carries very low yields and, in many cases, low return prospects, but you likely also don’t want to be 100% investing in equities, especially at these valuations.  Thus, we would view a high yield bond allocation as a potential way to generate what we see as attractive yield income within the fixed income space without having to sacrifice return potential.

Turning to the more income-focused investors, a big component of the high yield bond market’s return over the past few decades has been the notable yield/income these securities generate.  These are corporate bonds that carry coupons that must be paid semi-annually.  While high yield bonds do come with higher perceived risk than then their investment grade corporate counterpart, many munis and governments, we have seen that even accounting for this risk of loss, these bonds have performed better than certain fixed income sectors, as profiled via the 25-year index returns above.   But in looking at the high yield market versus these other fixed income asset classes, there is one area where we do see less risk and that is in terms of interest rate risk.

As it has been well-telegraphed that the Fed intends to raise rates this year, investors are left to speculate what that will mean for their portfolio.  While we believe that the Fed will not be aggressive with rates and even if they do take a couple of rate increases, we won’t see much impact on the long end of the curve (rather curve flattening), interest rate risk is a very real and valid concern for investors.  The high yield market has less interest rate risk as measured by duration and a higher yield, as profiled below.3

FI ylds, duration 1-27-17

There are a number of reasons why high yield bonds currently and historically carry a lower duration/less interest rate risk, including the higher starting coupon income and the fact this asset class is much more tied to credit quality, which improves as economies improve—and rates are generally increasing in periods of economic improvement.  Historically high yield bonds have performed well during rising rate environments (for further details and data, see our writings “Strategies for Investing in a Rising Rate Economy” and “The Election Impact on the High Yield Market: Rates and Regulation”).

Not only do high yield bonds benefit from their lower duration/lower interest rate risk, but we believe the higher tangible yield/income they generate is attractive relative to what is available from other fixed income sectors and warrants a look for those investors focusing on income generation.  A few rate increases won’t do much to change the low yield environment we are currently in, so the hunt for yield will likely persist.  Furthermore, given the historical risk and return profile versus equities, we also believe the high yield market is worth a look for more return-focused investors as an equity alternative. While we have our concerns about the high yield indexes (see our commentary, “The Year of Active Management”), we believe an actively managed high yield bond portfolio can be a viable investment option for a variety of investors in today’s environment.

For information on the AdvisorShares Peritus High Yield ETF (ticker: HYLD), the actively managed high yield exchange traded fund that the Peritus team is sub-advisor to, please visit, www.advisorshares.com/fund/hyld, distributed by Foreside Fund Services, LLC.

1 Bloomberg Barclays Capital U.S. High Yield Index covers the universe of fixed rate, non-investment grade debt (source Barclays Capital). Bloomberg Barclays US Corporate Investment Grade Index consists of publicly issued U.S. corporate and specified foreign debentures and secured notes that meet the specified maturity, liquidity, and the quality requirements (source Barclays Capital). Bloomberg Barclays Municipal Bond Index covers the long-term, tax-exempt bond market (source Barclays Capital). The S&P 500® is a market-value weighted index of 500 selected common stocks, most of which are listed on the New York Stock Exchange. It is widely recognized as representative of the equity market in general.  Returns are annualized annual return, covering the period 12/31/91 to 12/31/16.
2  Bloomberg Barclays Capital U.S. High Yield Index covers the universe of fixed rate, non-investment grade debt (source Barclays Capital). S&P 500 numbers based on total returns. Period covered is 12/31/91 to 12/31/16. Calculations based on monthly returns and standard deviation is calculated by annualizing monthly returns. Return/risk is based on annualized total return/annualized standard deviation. Although information and analysis contained herein has been obtained from sources Peritus Asset Management, LLC believes to be reliable, its accuracy and completeness cannot be guaranteed. This report is for informational purposes only. Any recommendation made in this report may not be suitable for all investors. As with all investments, investing in high yield corporate bonds and other fixed income securities involves various risks and uncertainties, as well as the potential for loss. Past performance is not an indication or guarantee of future results.
3  Bloomberg Barclays Capital U.S. High Yield Index covers the universe of fixed rate, non-investment grade debt (source Barclays Capital). Bloomberg Barclays US Corporate Investment Grade Index consists of publicly issued U.S. corporate and specified foreign debentures and secured notes that meet the specified maturity, liquidity, and the quality requirements (source Barclays Capital). Bloomberg Barclays Municipal Bond Index covers the long-term, tax-exempt bond market (source Barclays Capital). Bloomberg Barclays Municipal Bond: Taxable Bond Index is a rules-based, market value weighted index engineered for the long-term taxable bond market (source Barclays Capital).  U.S. 5 Year Treasury Note is the on-the-run Treasury (source Bloomberg).   Barclays data as of 1/27/17 and Treasury data as of 1/30/17. Yield to Worst is the lowest, or worst, yield of the yield to various call dates or maturity date. Duration is the change of a fixed income security that will result from a 1% change in interest rate. The duration calculation is based on the yield to worst date, using Macaulay duration for the various Barclays indexes and Bloomberg calculated duration to workout for 5-Year Treasury.
Posted in Peritus

High Yield Market: Upcoming Maturities

One thing we look at as a high yield bond investor is the amount of upcoming maturities, as it can be important as we think about both defaults and the supply of new bonds.  Below are the amount of upcoming maturities, charted by year for by both bonds and loans.1

Maturity Schedule

Focusing on the bond market, as we look at forward default expectations, upcoming maturities are certainly a consideration.  Very, very few bonds are actually taken out with cash at maturity.  Rather, companies look to issue new bonds or bank debt to refinance their existing debt prior to maturity which can be anywhere from a few months to years before the bonds mature.  The problem becomes that if the company is in a weak position and the market demand/interest is not there for them to refinance and repay their bonds, then a maturity can be a default trigger.  Whether they have been paying the interest on a bond or not, if they can’t repay principal at maturity it generally results in a default.  Looking at the next two years, this shows about $133 billion in high yield bonds maturing.  This is a relatively small number at less than 10% of the total high yield bond market value.2  Seeing this low dollar amount of maturities supports the very benign default outlook (see our piece, “High Yield Default Rate: 2016 Review and 2017 Outlook”).

The other reason as high yield investors we look at the amount of upcoming maturities is that it is an indication of future supply.  We don’t have a large maturity wall in the coming years, but things start to pick up in 2019 and beyond.  As mentioned above, companies often look to refinance their bonds years ahead of a maturity.   Currently we are seeing a number of new issues coming to market to take out maturities through 2021.  In 2016, we saw primary market activity of $286bn in total USD high yield bond issuance, with 58% of that related to refinancing activity.3   Projections are for issuance to total $300bn in 2017, so a slight increase y/y, with about 50%, or about $150bn due to refinancing activity.4  Looking at the upcoming maturities, this 2017 issuance projection certainly seems reasonable.

In late 2015, as we looked at ways to potentially increase the liquidity and dampen volatility within our strategy, we decided to allocate a portion our portfolio to new issue bonds, as our experience and market research indicated that bonds tend to be most liquid immediately following issuance.  While these are short-term holdings, we believe this strategy has effectively met our goals in terms of liquidity and volatility.  Given the expectation of a steady supply of newly issued bonds, due largely to the refinancing referenced above, along with other use of proceeds such as mergers and acquisitions and general and corporate purposes, we expect that there will be ample supply for us to continue with this strategy for the foreseeable future.

A strong new issue market over the past several years and issuers continually looking to extend maturities and refinance existing bonds has positioned as well in terms of the low amount of maturities over the next couple years, boding well for default rates, and a continued supply of refinancings for future years, supporting our ability to continue to execute our new issue strategy.

1  Jantzen, Nelson, CFA and Peter Acciavatti, “JPM High-Yield and Leveraged Loan Morning Intelligence,” J.P. Morgan North American Credit Research, January 17, 2017.
2  Acciavatti, Peter, Tony Linares, Nelson Jantzen, CFA, Rahul Sharma, and Chuanxin Li. “Credit Strategy Weekly Update,” January 20, 2017, p. 41, indicated high-yield bond market value of $1.9trillion.
3 Acciavatti, Peter, Tony Linares, Nelson Jantzen, CFA, Rahul Sharma, and Chuanxin Li. “High-Yield Market Monitor,” January 3, 2017, p. 11.
4 Acciavatti, Peter, Tony Linares, Nelson Jantzen, CFA, Rahul Sharma, and Chuanxin Li. “2016 High-Yield Annual Review,” December 29, 2016, p. 11.
Posted in Peritus

Visit Peritus at the Inside ETF Conference

Ron Heller, CEO of Peritus Asset Management, will be at the Inside ETF conference in Hollywood, FL this week.  He’ll be available at the AdvisorShares booth #702 to discuss our portfolio, strategy, and outlook for the high yield market.

Posted in news

The Year of Active Management

The Bank of America Merrill Lynch US High Yield Index currently carries a weighted average yield to worst of 5.9%, a yield to maturity of 6.3%, a spread to worst of 423 bps, an average coupon of 6.5%, and average price of $100.40.1  The Bloomberg Barclays High Yield index is virtually the same, currently also carrying a weighted average yield to worst of 5.9%, a yield to maturity of 6.3%, a spread to worst of 424 bps, an average coupon of 6.5%, and average price of $100.65.2  While you can’t technically “buy” an index, they do provide a snapshot of what the broad high yield market looks like.  However, digging down into the individual index constituents is even more telling of what sort of value is available in today’s market.

If we look at the nearly 2,000 individual bond tranches in the Bank of American Merrill Lynch US High Yield Index, nearly 74% of the index is over par ($100), 62% of the index $102 or above, and over 40% of the index is priced at $104 or above.  Nearly 50% of the index is trading at a current yield of 6% or under, while over 65% of the index is at a yield-to-worst of 6% or under and nearly 50% of the index is at a yield-to-worst under 5%.3

As we look through many of the individual securities available in the high yield market, we see a number of securities that we aren’t interested in as value-investors.  We see cases of very thin yields relative to the risk—again nearly 50% of the index is providing a yield-to-worst of under 5%, with many of those yielding 3-4%, which even in this low rate environment isn’t the sort of yield we are looking for as investors.  On the other end of the spectrum, we see weaker and highly levered credits that have caught a bid up in this market euphoria, but still carry extreme credit risk from our perspective—again putting yields in a place where we don’t see investors properly getting compensated and securities that we would avoid.

But all of that is not to say the entire high yield market is overvalued.  We still see a number of credits in both the high yield bond and loan space where yields are attractive relative to the risk being assumed—we continue to see the opportunity to build a portfolio with what we see as attractive yield/income metrics without having to take on undue risk.  As noted, there are nearly 2,000 individual tranches and nearly $1.4 trillion in market value in this high yield bond index alone4, so plenty of merchandise to choose from for selective investors to build a well-diversified portfolio.

We are eight years into the cycle and while we do see a number of reasons that this market can continue to run (i.e., spread levels are still far from historic lows and the lows we often see before the cycle turns, credit fundamentals are still reasonable, market technicals remain strong, default rates are expected to be well below historical averages, real economic improvement could finally begin this year in turn benefiting credit, etc.), we also believe that there is enough uncertainty and we are far enough into this cycle that investors should execute a degree of caution.  We certainly don’t want to ignore the high yield debt market altogether, as we do continue to see it as a source of attractive, tangible yield/income for investors and the added potential for capital gains, but again, caution and selectivity are warranted.  As we look over the next few years, we believe the one-way, broad high yield debt market trade up has ended and what you own in terms of individual securities will matter much more than it has over the last year.  The high yield indexes and passive products that track those indexes don’t put credit analysis, from both a fundamental and technical side, at the forefront of their criteria for security inclusion, however we believe this analysis will become all the more important in the years ahead.  Many market commentators have said this will be the year of active management in the equity market, and we believe that rings just as true in the high yield debt market.

For information on the AdvisorShares Peritus High Yield ETF (ticker: HYLD), the actively managed high yield exchange traded fund that the Peritus team is sub-advisor to, please visit, www.advisorshares.com/fund/hyld, distributed by Foreside Fund Services, LLC.

1  Data as of 1/12/17, sourced from Bloomberg.  The Bank of America Merrill Lynch US High Yield Index monitors the performance of below investment grade U.S. dollar-denominated corporate bonds publicly issued in the U.S. domestic market.
2  Data as of 1/12/17, sourced from Barclays Capital.  The Bloomberg Barclays US High Yield Index covers the universe of fixed rate, non-investment grade debt.
3  Based on the individual bond tranches in the Bank of America Merrill Lynch US High Yield Index, using the January 2017 universe.  Data as of 1/12/17, sourced from Bloomberg.  Percentages based on the sum of total weights for each individual security in the category.
4  Data for the Bank of America Merrill Lynch US High Yield Index as of 1/12/17, sourced from Bloomberg.
Posted in Peritus

The High Yield Bond Market: 2016 Review, 2017 Outlook

We entered 2016 coming off a tough year for the high yield market.  The free fall in energy and other commodity prices over the course of 2015 not only caused a collapse in bonds in the energy and commodity sectors, but the pricing declines spread to the entire high yield market, as these two sectors together made up over 20% of the high yield index going into that year, with energy alone about 18% of the index.1  The spread and yield on the high yield market had widened from 373 bps and 4.9%, respectively, in mid-2014, prior to the energy rout, all the way to 706 bps and 8.7%, respectively, to close out 2015.2  We reached high of 897 bps on the spread and 10.1% on the yield-to-worst in mid-February 20163, and then saw a rebound in high yield as energy prices stabilized and market participants found value in the broader high yield market.  We closed out 2016 with a strong return of 17.1%.4

hy-annual-returns-30yr-history-12-31-16

As we entered 2016, we believed the high yield bond market was hugely undervalued (see our writings “The High Yield Market Repricing: An Opportunity” and “A Negative 2015, but an Opportunity Ahead”), and investors who stepped in reaped the rewards over the year.  But often the concern after a very strong year of returns becomes, is there room for the market the run further?  While we don’t anticipate returns as high as we saw in 2016 in the coming year, we do believe that the high yield market remains positioned to generate attractive returns in 2017.

First, we need to keep this 2016 return in context: again, it was coming off a very negative 2015 and bond prices/spreads were at levels not seen since the financial crisis.  Looking at the return over the last two years, together those years returned 11.9%, or 5.8% per year on an annualized basis.5  As a point of context, looking at the returns for the high yield bond market over the last 30 years, the annualized return over this period is 8.3%6.  Thus, what we have seen over the last two years certainly isn’t high by any historical standard.  So yes, we saw a big move last year but that was due to the dramatically undervalued market and pricing going into 2016.

As we sit today, we can’t make the call that a huge portion of the high yield market is undervalued as we could a year ago.  Instead, with the run we had in 2016, this is now a much more normalized market, as we see some of the market as overvalued, along with some securities that are fairly and undervalued.  The index ended the year with an average price of $99.80, which to put in some perspective is down from the average price of $105.77 a year and a half ago, right before the decline in the high yield market began.7  At that time (June 2014), the average spread on the market was 373 bps and the yield 4.9%, versus the average spread of 442 bps and yield of 6.1% at the end of 2016.8  So some spread compression, in addition to the average coupon on the high yield bond index of 6.5%, doesn’t seem out of the question.9  Interestingly, the yield on the 10-year Treasury was just about the same back in June 2014 compared to YE 2016.10   On the risk side, default rates are expected to be well below historical averages this year (see our recent writing, “High Yield Default Rate: 2016 Return and 2017 Outlook”).

Spreads have compressed over the last year and prices for many bonds are now at premiums.  In some cases, yields are so low we don’t see that investors are getting properly paid for the risk.  Yet, there are still what we see as attractive investment opportunities for active managers who can look for value.  There are still bonds that offer what we see as compelling yield given the risks of the security and while the capital gains opportunities are not as wide-spread as they were a year ago, there are still discounts available.  Even a few points of price appreciation along with a steady coupon income can bring with it a very attractive total return for an investment.  The goal of active management is to provide performance superior to that offered by an index and we feel that today’s high yield market offers that opportunity for active high yield investors; in fact, we believe active management will matter much more in 2017 than it did in 2016.

For information on the AdvisorShares Peritus High Yield ETF (ticker: HYLD), the actively managed high yield exchange traded fund that the Peritus team is sub-advisor to, please visit, www.advisorshares.com/fund/hyld, distributed by Foreside Fund Services, LLC.

1  Approximate sector market weights as of the end of 2014.  Acciavatti, Peter D., Tony Linares, Nelson Jantzen, CFA, Rahul Sharma, and Chuanxin Li. “2014 High-Yield Annual Review.” J.P. Morgan, North American High Yield and Leveraged Loan Research. December 29, 2014, p. A90, A91
2  Index referenced is the Bloomberg Barclays US High Yield Index, which covers the universe of fixed rate, non-investment grade debt. Data sourced from Barclays Capital, as of 6/30/14 and 12/31/15. Yield referenced is the yield-to-worst and spread referenced is the spread-to-worst.  Yield-to-worst is the lowest, or worst, yield of the yield to various call dates or maturity date.
3  Index referenced is the Bloomberg Barclays US High Yield Index, which covers the universe of fixed rate, non-investment grade debt. Data sourced from Barclays Capital, as of 2/11/16, the high in spreads and  yields. Yield referenced is the yield-to-worst and spread referenced is the spread-to-worst.
4  Annual performance of the Bloomberg Barclays High Yield Index for the period 1/1/1987 to 12/31/2016.
5  Cumulative and annualized performance of the Bloomberg Barclays High Yield Index for the period 1/1/2015 to 12/31/2016.
6  Annualized performance for the Bloomberg Barclays High Yield Index for the period 1/1/87 to 12/31/16.  Data sourced from Barclays Capital.
7  Average price for the Bloomberg Barclays High Yield Index as of 12/31/16 and 6/30/14.  Data sourced from Barclays Capital.
8  Spread-to-worst and yield-to-worst for the Bloomberg Barclays High Yield Index as of 12/31/16 and 6/30/16.  Data sourced from Barclays Capital.
9  Average coupon for the Bloomberg Barclays High Yield Index as of 12/31/16 and 6/30/14.  Data sourced from Barclays Capital.
10  Yield on 10-year Treasury was 2.53% on 6/30/14 and 2.45% on 12/31/16.  Data sourced from the US Department of Treasury.
Posted in Peritus

Is There a Place in Portfolios for Fixed Income?

The widely held assumption as we enter 2017 is that this will be the year we see the Fed take real action.  While we aren’t convinced that longer term (5 and 10yr) Treasury rates move much further from where we closed out the year given the global demographics and economic headwinds (see our piece, “The Election Impact on the High Yield Market: Rates and Regulations”), for those concerned about rates, is there a place for fixed income investing?

We ended 2016 with the 5-year Treasury yield at 1.93% and the 10-year at 2.45%, which is up a mere 20bps from where we ended 2015.  However, over the course of the year, it was a wild ride for Treasuries.  Yields fell as low as 0.94% on the 5-year and 1.37% on the 10-year in early July 2016 and spiked as high as 2.07% and 2.6%, respectively, in mid-December.1  However, over that period from early July to the end of December when we saw rates climb more than 110bps, the high yield bond market had a strong performance, up 6.79% over that nearly six month period.2

hy-vs-treas-12-31-16

The same cannot be said for other areas of fixed income.  Investment grade and municipal bonds both had negative returns over the same period in the face of rising rates.3

fi-indexes-12-31-16-6mos

We have noted time and again in our writings, high yield bonds have historically performed well during periods of rising interest rates (as measured by Treasury yields), and the last six months again supports that (see our writings, “Strategies for Investing in a Rising Rate Environment,” “High Yield in a Rising Rate Environment,” and “The Election Impact on High Yield: Rates and Regulation” for further data on high yield bond market performance as rates increase).  However, with their higher correlation to Treasuries, lower starting yields, and higher duration, investment grade corporates, municipals, and other areas of fixed income are much more exposed to interest rate moves.4

fi-stats-12-29-16

Whether rates rise or not, we don’t see investment grade corporates or municipal bonds as an attractive investment option as we sit today.   Here you are faced with yields that are nearly half that of those offered by the high yield market and much higher interest rate risk given the average maturity profile is four or more years longer.

Looking back over the last 25-year history, the high yield bond market has had a 160-260bps return advantage over investment grade and munis, and we don’t see anything that would change that return advantage going forward.5

25-yr-return-history-fi-2016

The gut reaction of investors seems to be to flee fixed income at the first hint of an increase in interest rates.  We would see this as a valid reaction for many areas of the fixed income market, but not for high yield debt.  With what we see as an attractive yield relative to other areas of fixed income, we believe high yield bonds have a place in investment portfolios going forward, irrespective of what happens with interest rates.

1  The 2016 low was on July 5, 2016.  Other data as of 12/31/15 and 12/31/16.  Data sourced from U.S. Department of Treasury.
2  Bloomberg Barclays US High Yield Index covers the universe of fixed rate, non-investment grade debt.  Data for the period of 7/5/16 to 12/31/16 source Barclays Capital and U.S. Department of Treasury.
3  Bloomberg Barclays Corporate Investment Grade Index consists of publicly issued U.S. corporate and specified foreign debentures and secured notes that meet the specified maturity, liquidity, and the quality requirements (source Barclays Capital). Bloomberg Barclays Municipal Bond Index covers the long-term, tax-exempt bond market (source Barclays Capital).  Cumulative returns presented, for the period 7/5/16 to 12/31/16.
4  Data as of 12/29/16, source Bloomberg and Barclays Capital.  Yield to Worst is the lowest, or worst, yield of the yield to various call dates or maturity date. Duration is the change of a fixed income security that will result from a 1% change in interest rate. The duration calculation is the modified adjusted duration for the indexes and Bloomberg calculated duration to workout for 5-Year and 10-year Treasury.
5  Data covers the period 12/31/1991 to 12/31/2016, data sourced from Barclays Capital.
Posted in Peritus

Peritus in the News

Peritus was mentioned in the article, “6 Best Bond ETFs of 2016—High Yield Tops,” by Sanghamitra Saha of Zacks, December 21, 2016.

Posted in news