There have been recent headlines about yields in the high-yield market hitting all-time lows.  Yes, this is true, but let’s put this in some context.  First, interest rates have been at or near all-time lows for years, pressuring yields in all fixed income securities as investors search for places to generate returns.  Comparatively, we believe the high yield market still looks very attractive.¹

Second, yields are merely one metric to look at as you evaluate “value” in the high yield market.  We believe, especially in this low-yield environment, that spreads (or the difference in yield between the yield-to-worst on the high yield market and comparable maturity Treasuries) is a better way to monitor levels in the high yield market. So, let’s take a look at historical spreads:²

One thing to note in looking at the chart above is that there are several spikes in spreads that upwardly skew the average numbers.  If you look at the data and remove these “systemic shocks” (the periods from 9/30/89 -12/31/91, 5/31/2000-6/30/03, and 6/30/08-11/30/09), the average spread to worst goes from 585bps to 487bps, and the median spread moves from 521bps to 468bps.  It’s also important to realize that nearly two-thirds of the time over the entire 28 year plus period spreads have been under the 600bp level.  The all-time lows on spreads was 271bps, set in 2007, and we have also spent a good chunk of time at spreads sub-400bps over history.³  So as we sit today at spreads of right around 400 bps, we are certainly far off all-time lows here.  It should also be noted that the spreads between investment grade and high yield bonds stands at 312bps, also well off the all-time low of 176bps.⁴

This begs the question, can spreads tighten further, despite the all-time low yields?  We believe so, for a number of reasons. First, we expect the demand for yield and fixed income products is in the early phases, as demographics will become more of a factor in the years to come, which we expect to keep rates low and continue to drive investors to yield-bearing products, including the high yield market (see our piece “Of Elephants and Rates”).  Second, there remains a strong fundamental backdrop to the high yield market.  Leverage levels for high yield companies remain relatively stable.  Total leverage ratios of 4.10x are just slightly higher than the cycle-low of 3.87x seen in the third quarter of 2012.⁵  Net leverage is even more moderate, at 3.5x.⁶  Additionally, default rates currently stand at 0.73%⁷ (excluding TXU), versus a historical average of about 4%, and are projected to remain below average for the next couple of years.⁸

We believe that there is still value to be had for investors in today’s high yield market.  For more detail behind the yield values for the indexes and the negative convexity issue that hampers the high yield index-based, passive products that don’t have the ability/mandate to sell securities, see our blog, “The True Opportunity in Today’s High Yield Market.”  We believe that the value in today’s market is there for active managers who can parse through the best opportunities for investment in the space and who have the ability to sell securities that trade at large premiums to call prices.

¹  Barclays Capital U.S. High Yield Index covers the universe of fixed rate, non-investment grade debt (source Barclays Capital).  U.S. 5  and 10 Year Treasury Note is sourced from the U.S. Department of Treasury, Daily Treasury Curve Rates, http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield. 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).  Barclays Municipal Bond Index covers the long-term, tax-exempt bond market (source Barclays Capital). All data as of 5/31/14 for all indexes, except data as of 6/2 for the U.S. 5 and 10 Year Treasury.

²  Data sourced from Credit Suisse, as of 5/31/14.  Historical spread data covers the period from 1/31/1986 to 5/31/2014.  The Credit Suisse High Yield Index is designed to mirror the investible universe of the $US-denominated high yield debt market.

³  Analysis based upon scenario testing of the spread data from 1/31/1986 to 5/31/14 for the Credit Suisse High Yield Index.

⁴  Acciavatti, Peter D., Tony Linares, Nelson Jantzen, CFA, Rahul Sharma, and Chuanxin Li.  “Credit Strategy Weekly Update.”  J.P. Morgan, North American High Yield and Leveraged Loan Research, May 22, 2014, p. 5-6.  Data as of May 21, 2014.

⁵  Acciavatti, Peter D., Tony Linares, Nelson Jantzen, CFA, Rahul Sharma, and Chuanxin Li.  “Credit Strategy Weekly Update.”  J.P. Morgan, North American High Yield and Leveraged Loan Research, June 6, 2014, p. 13.  Total leverage ratios as of Q1 2014.

⁶  Acciavatti, Peter D., Tony Linares, Nelson Jantzen, CFA, Rahul Sharma, and Chuanxin Li.  “Credit Strategy Weekly Update.”  J.P. Morgan, North American High Yield and Leveraged Loan Research, June 6, 2014, p. 13.  Net leverage ratios as of Q1 2014.

⁷  Acciavatti, Peter D., Tony Linares, Nelson Jantzen, CFA, Rahul Sharma, and Chuanxin Li.  “Credit Strategy Weekly Update.”  J.P. Morgan, North American High Yield and Leveraged Loan Research, June 13, 2014, p. 46.  Default rates exclude TXU, which due to its disproportionate size skew the numbers.  The current default rate including TXU is 2.08%.

⁸  Acciavatti, Peter D., Tony Linares, Nelson Jantzen, CFA, Rahul Sharma, and Chuanxin Li.  “High-Yield Default Monitor.”  J.P. Morgan, North American High Yield and Leveraged Loan Research, June 2, 2014, p. 5.