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.

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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

Peritus in the News

Tim Gramatovich, Peritus’ Chief Investment Officer, was quoted in the article “High-Yield Insight: Pivot points for HY in 2017 amid mixed outlook,” by Matt Fuller of LevFin Insights, December 15, 2016.

Posted in news

High Yield Default Rate: 2016 Review and 2017 Outlook

In early 2016, oil was heading into the $20s and market prognosticators were expecting that we’d see a huge spike in energy and commodity related defaults in 2016 and that would continue into 2017.  The projection was for a 6% default rate in 2016 for the entire high yield market. 1  As of the end of November, we are looking at 4.7% default rate (including distressed debt exchanges) for the entire high yield bond market, which was dominated by the Energy and Metals/Mining sectors.2  J.P. Morgan recently noted that 84% of 2016 default activity was from commodity related companies, while just $9.3bil over 19 companies defaulted in 2016 in non-commodity sectors, putting the default rate ex-commodities at a very low 0.6%.3

High Yield Bond Default Rates

jpm-par-weighted-default-rate-12-16

With the weakest of the commodity companies now weeded through and the stability we have seen in energy and commodity prices over the last 6+ months, the projection is now for the default rate to fall down to 2.5% in 2017, putting it well below the historical average of about 4%.4

High Yield Bond Default Rates and Outlook5

jpm-projected-default-rates-2017

J.P. Morgan isn’t alone in their projections for a significant decline in defaults.  Others, including Credit Suisse, profiled below, have similar outlooks with the expectation that both energy/commodity defaults will decline significantly, as will the total high yield bond market rate.6

Energy Default Rates Expected to Collapse

cs-energy-default-rates-expected-to-collapse

High Yield Bond Default Rates Expected to Halve

cs-default-outlook-2017

While some seem to be concerned about the impact of higher interest rates on the high yield market, investors need to be aware that the biggest driver of spreads historically is not interest rates (interest rate risk) but rather the default rate and outlook (default/credit risk). As the chart below profiles, spreads spike (bond prices decline/yields increase) when the expectation is for an increase in default rates, and vice versa, as the outlook for defaults decline, spreads tighten (prices increase) historically.7

hy-spreads-vs-default-rates-10yr

So whether you believe the new administration’s potential tax, infrastructure, and job initiatives drive the economy and rates along with it, or you believe Treasury rates won’t rise much from where they already are in this post-election euphoria, we don’t expect rates to be the primary driver of the high yield market.  Credit/default risk remains at the core of spread movement and as we look into 2017, we believe that the benign default outlook bodes well for the argument for further spread tightening/bond prices increasing in 2017 in the high yield market.  Additionally, adding an effective active management overlay on top of this can help to further stem default exposure.

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  Acciavatti, Peter, Tony Linares, Nelson Jantzen, CFA, Rahul Sharma, and Chuanxin Li. “Credit Strategy Weekly Update,” March 1, 2016, p. 5
2  Acciavatti, Peter, Tony Linares, Nelson Jantzen, CFA, and Chuanxin Li, “2017 High-Yield and Leveraged Loan Outlook,” J.P. Morgan North American Credit Research, December 2, 2016, p. 5.
3  Acciavatti, Peter, Tony Linares, Nelson Jantzen, CFA, and Chuanxin Li, “2017 High-Yield and Leveraged Loan Outlook,” J.P. Morgan North American Credit Research, December 2, 2016, p. 5.
4  Acciavatti, Peter, Tony Linares, Nelson Jantzen, CFA, and Chuanxin Li, “2017 High-Yield and Leveraged Loan Outlook,” J.P. Morgan North American Credit Research, December 2, 2016, p. 5.
5 Acciavatti, Peter, and Nelson Jantzen, CFA “ JPM High-Yield and Leveraged Loan Morning Intelligence,” December 5, 2016.
6 Koch, Fer, Miranda Chen, James Esposito, and Emma Dougall, “CS US Credit Strategy 2017 Outlook,” Credit Suisse, December 14, 2016, p. 24.
7  Data sourced from Peter Acciavatti, and Nelson Jantzen, CFA “ JPM High-Yield and Leveraged Loan Morning Intelligence,” December 5, 2016.
Posted in Peritus

The Floating Rate Loan Market: More to Consider

For those concerned about interest rates rising, turning to the floating rate loan market may seem like it could be a great alternative.  Over the past few weeks, as we have seen the expectation for higher rates firmly take hold and a spike in Treasury yields, floating rate loans (also called leveraged loans) are once again becoming a popular trade.  We have seen substantial inflows into the asset class, with last week’s inflow among the largest on record, only slightly surpassed by the inflows we saw during the summer of 2013 “Taper Tantrum.”1  Investing in loans is a currently hot strategy and to some maybe even a no brainer—if rates go up, the coupon payment you get goes up so you can’ t lose, right?  But of course, like most things in investing, it is not that simple.  We see a few challenges with this market.

First, is valuation/potential capital appreciation. With the recent flood of interest into the loan market, this now leaves over 75% of the loan index trading at $99.50 or above.2  Unlike in the bond market, we generally don’t see large call premiums in the loan market and minimal call/prepayment protection.  The issuer may have to pay a slight premium ($101) to call during the first 6mos to couple years, but nothing compared to the call restrictions and much higher premiums faced in the bond market.  This means for the loan market, most loans can be called at any time after issuance right around par or very slightly above, which in turn limits the pricing upside for loans.  Thus, with such a large portion of the market already right around par, we would see limited ability for capital appreciation in the loan market as a whole, curtailing an important component in generating total returns.

Our second consideration/challenge, is the floating rate coupon itself.  Most of the floating rate loans are tied to 3-month LIBOR, with the coupon resetting every 3 months.  Many, if not most, loans also have LIBOR floors of 1-1.5%, meaning 3-month LIBOR needs to move above this level before the loan even begins to float.  Ever since August when investors began preparing for new money market regulations to go into effect, we have seen 3-month LIBOR move up significantly and is currently now right around that 1% level.3  So, we going to be hitting floors and rates paid on these loans will be going up.  On one hand, that is good news for investors who are betting on this as a way to play rising rates.  However, on another hand, that means the interest cost for the issuers is increasing, in some cases significantly.  Investors need to be paying attention to the higher interest rate bill and the company’s ability to handle it, especially in very loan-heavy capital structures, as well as assess the impact on cash flow generation and the company’s ability to invest in the business—paying more in interest means that the company now has less funds available for things such as capital spending and debt paydown.

On the flip side of the rising coupon due to the floating rates, is the risk of a lower coupon, as massive interest in and demand for loans creates an environment whereby financially strong issuers look to re-price their loans.  With the currently hot market and minimal prepayment protections on loans, we are already seeing a huge wave of loan repricings, where by issuers are coming back to the market to lower the rate they have to pay on the loan, leading to a lower coupon for the investor.  We have seen issuers undertake multiple repricings on a single loan within a year, and even one issuer came back to the market for a repricing recently after just issuing the loan a month ago.  Approximately 13% of the loan universe has re-priced since May and $117bn in total re-pricing volume year-to-date, with $51bn of that in just the last quarter.  This compares to $63.5bn in repricing volume in all of 2015.4  So just because the underlying rate is “floating” up, that doesn’t mean that the company won’t look to lower the spread and in turn lowering the income investors receive.

The final issue to consider is the lack of correlation between LIBOR and US Treasury bond yields.  Investor are seeing the 5- and 10-year Treasury rates increasing and many see floating rate loans as a way to capitalize on rising rates.  However, they need to keep in mind they are talking about different “rates” that are driven by different factors.  As noted above, the floating rate on loans are generally based on 3-month LIBOR.  LIBOR is a global rate (London Interbank Offering Rate), while Treasuries are driven by domestic factors.  Looking over the past few years, we have seen spikes in Treasury rates, such as in 2013 and mid-2015, all the while LIBOR barely moved.  LIBOR began it accent upward several months ago (due to regulation changes, see our piece “Loans: Understanding the Floating Rate“), at the same time Treasury yields were hitting multi-year lows.5

libor-vs-10yr-12-14-16

So, yes, loans currently are providing a benefit from LIBOR increasing, but that certainly hasn’t historically been in lock step with Treasuries.

Loans are a floating rate option in today’s market and due to that floating rate, theoretically have minimal duration/interest rate risk.  But investors can’t blindly think it is a no-brainer trade.  The interest obligation needs to be assessed relative to the company’s cash flow and investors need to keep in mind that LIBOR rates can move independently from Treasury rates, so this isn’t a perfect play on an increase in US Treasury rates.  With the recent flood of interest into the loan space, much of the loan market is trading at low yields and right around par, which doesn’t allow for much, if anything, in the way of capital gains potential and the recent wave of re-pricings has moved coupons downward.  Given this, we don’t think it is the right move to abandon the high yield bond market in favor of loans as we do see better upside in bonds.  As an active manager that can pick and choose securities, we do see select value in certain floating rate loans and we have the flexibility within our high yield strategy to allocate a portion of our strategy to loans, which does serve in reducing total duration, but our focus remains on working to generate alpha (yield and capital gain potential) primarily via the high yield bond market.  Whether rates rise or not, we believe that active management is essential in the loan market just as it is in the high yield bond 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  Acciavatti, Peter, Tony Linares, Nelson Jantzen,  CFA, Rahul Sharma, and Chuanxin Li, “Credit Strategy Weekly Update,” North American Credit Research, December 9, 2016, p. 4.
Jantzen, Nelson and Peter Acciavatti, “JPM High-Yield and Leveraged Loan Morning Intelligence,” December 16, 2016.
3  3-month LIBOR as of 12/14/16, data sourced from Bloomberg.
4  Jantzen, Nelson and Peter Acciavatti, “JPM High-Yield and Leveraged Loan Morning Intelligence,” December 16, 2016.
5  Data sourced from Bloomberg, for the period 12/31/12 to 12/14/16.
Posted in Peritus

The Election Impact on High Yield: Rates and Regulation, Regulatory Changes

Post November’s election, we see regulation as an area of potential impact on the high yield market—or more precisely the potential repeal of regulation.   The potential repeal of Obama Care is the headline that is getting the most attention.  We are already starting to see certain areas of healthcare within high yield, namely hospitals, get severely hit on the uncertainty over what this could look like and the potential impact any change could have on these individual credit issuers.  At some point these securities will have priced in a worst case scenario and may be a tremendous trade.  Given the speed of markets today, this is likely soon.

But the biggest potential regulatory change that may impact the entire high yield market relates to the potential repeal or modification of the Volcker Rule inside the Dodd-Frank Act.  This provision virtually eliminated proprietary trading at investment banks, which has in turn severely curtailed their participation in marketing making activities in the high yield sector.  As we have seen less dealer participation and inventory, we have seen an impact on liquidity and larger pricing swings in high yield bonds.  This has been something markets have adjusted to over the past couple years, but if some regulations were to be eased and market making activity were to increase, that could improve liquidity within the high yield market.

Liquidity within the bond market has been an area of scrutiny by investors and regulators alike in this post Dodd Frank/Volcker environment.  Rolling back or amending any sort of regulation on this front for the banks may serve to improve their profit levels and reduce compliance costs on not only them, but also the droves of other fund managers that have and will have to face additional compliance costs and reporting burdens as they address some the outcropping of rules addressing liquidity.  And if banks were able to once again more fully participate in market making activities, this could have the effect of potentially improving liquidity/lessening volatility within the corporate debt markets.  This is certainly something we will be paying close attention to.  While changes on this front could be a positive, even if none of this ultimately gets changed, Peritus has been proactively addressing some of investors’ liquidity concerns with recent strategy enhancements (see our piece “Liquidity Management” and read monthly manager commentaries at www.advisorshares.com/fund/hyld) and we believe these enhancements position us well within the current environment.  For more on our thoughts on the economy, rates, regulations, and the outlook for the high yield market as a result of the recent election, see our piece “The Election Impact on High Yield: Rates and Regulation.”

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.

Posted in Peritus

The Election Impact on High Yield: Rates and Regulation, High Yield in a Rising Rate Environment

While the market seems to be jumping to the conclusion that infrastructure and other government spending and the benefit of lower taxes will drive growth and inflation, taking interest rates higher, we aren’t a believer that we will see dramatic move upward in rates from where we are now.  But while we are not a believer in a run in rates, let’s take that side of the trade for a minute.  For the sake of argument, let’s say the Fed raises the Fed Funds Rate 25bps this month and then does another 3, 25bps rate increases in 2017.  So now the Fed Funds Rate is up 1% and let’s assume over this year, Treasuries have increased 1% as well from the pre-election levels.  What would that mean for us in the high yield market?  First, we need to keep in mind that Treasury rates are forward looking so will price in expectations long before the Fed takes any action.  Additionally, we would expect the short end of the curve to get hit more, less so for the medium and longer end of the curve that matter more to us in the high yield market. Given the massive back up in rates over the last two weeks, the market has likely priced in much of this potential move.  In Street parlance, buy the rumor, sell the news.

History gives us a picture of how high yield has reacted during times of increasing rates.  During the more recent “Taper Tantrum” in 2013, we saw the 10-year move up 136bps from April 30th to December 31st 2013, and the 5-year move 107bps over that same timeframe.  During the first couple months of that Treasury move, we saw the 10-year increase about 80bps and while that increase was happening, the high yield market fell 3.1%.  But over the course of the rest of year (July-December), during which the 10-year moved up another 54bps, we saw the high yield market return 5.8%.1 Keep in mind, going into this move in rates in 2013, the yield-to-worst on the high yield index was 160bps lower in April 2013 than it is now, and was hitting all-time lows in yields right as the “Taper Tantrum” was beginning. 2  Not only that currently yields are right about where they were at the peak of the “Taper Tantrum.” 3  So the high yield market looks to have been more sensitive to changes in rates then versus where we are today given the yield levels at the time.

If we expand this view to look at the long-term 30-year history of the high yield market, we continue to see that the high yield market has performed well in the face of rate increases.4

interest-rate-grid-10-31-16

On average, returns have remained positive in the midst of the increases, and have performed very well over the next 3-6 months. So while we remain skeptics of a rising interest rate environment, we believe investors are well served by the high yield market whether rates rise or not.

For more as to the impact of rates and how the market has historically performed during periods of increases, see our writings “Strategies for Investing in a Rising Rate Environment” and “High Yield in a Rising Rate Environment”.  As noted in these pieces, historically the high yield market is negatively correlated to Treasuries, meaning as Treasury prices decline and rates/yields increase, high yield prices increase.  This market has historically performed well during years when we have seen rising rates, helped by the improving economy that has traditionally corresponded with increased rates, as well as the higher starting yields and a shorter maturities we generally see in the high yield market versus other fixed income sectors, both of which help reduce duration.

Duration is a measure of interest rate sensitivity, and that, along with yield, are important metrics to consider in the face of potentially higher rates.  Keep in mind the high yield market is not homogenous.  As we have seen a swift rebound in high yield bond prices so far this year, we have seen spreads compressed to very low yield levels on a number of high yield issues.  In looking at the Bank of America High Yield Index, nearly 40% of the individual tranches trade at a yield to worst of 5% or less5, while there is also a large portion of the market that offers yields that we would view as attractive.  So if we were to see a 1% increase in rates, that would have a much more significant impact on securities yielding 3% or 4% within the high yield market, along with investment grade and municipals that are yielding even less, versus the securities yielding 7, 8, 9% or even more, also available within the high yield space.  Yield is one of the main components of duration, so all else equal, the higher the yield, the lower the duration and vice versa, the lower the yield the higher the duration.  This is just one way where an actively managed approach can add value.

While we are not believers in the rising rate story, for those who do believe that rates are bound to rise from here, we see our high yield bond and loan asset classes as one of the few places inside the fixed income universe that investors can make money.  For more on our thoughts on the economy, rates, regulations, and the outlook for the high yield market as a result of the recent election, see our piece “The Election Impact on High Yield: Rates and Regulation.”

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 Based on performance for the Bank of America Merrill Lynch High Yield Index.  The Bank of America Merrill Lynch High Yield Index monitors the performance of below investment grade U.S. dollar-denominated corporate bonds publicly issued in the U.S. domestic market.  Index data sourced from Bloomberg.
2 Yield referenced is the yield-to-worst on the Bank of America Merrill Lynch High Yield Index for the dates 4/30/2013 versus 11/14/16.
3 Yield referenced is the yield-to-worst on the Bank of America Merrill Lynch High Yield Index with the top during the 2013 period of 6.85% on 6/15/2013 versus 6.86% on 11/14/16.
4 Data analyzing the month end levels of the 10-yr US Treasury yield versus the monthly returns for the Bank of America Merrill Lynch High Yield Index, looking specifically at performance for the High Yield Index during periods when the 10-year yield moved above the noted thresholds from one month end to another.  Intra-month data was not analyzed.  Trailing performance numbers are for the prior 6 months and 3 months before the month end in which we saw the Treasury yield cross the threshold, for the current month in which is crossed threshold and for the one, three, and six month periods after the calendar month in which Treasury yields cross the threshold.  Data sourced from Bloomberg and covers the period of 12/31/1986 to 10/31/2016.
5 The Bank of America Merrill Lynch High Yield Index monitors the performance of below investment grade U.S. dollar-denominated corporate bonds publicly issued in the U.S. domestic market.  Index data sourced from Bloomberg, as of 11/7/16.
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