There has been a good amount of coverage over the past couple weeks of the fact that the high yield indexes have reached record low levels on a pure yield basis. So, this naturally leads to the question, is there anything left to be had in high yield?
Our answer is undoubtedly yes. First it should be noted that we are nowhere near record lows from a spread perspective1:
The reality is that spreads are just slightly below the 20-year median level, which to us still seems pretty reasonable given the very benign default outlook for high yield bonds2 and wide open new issue market, as well as the record levels of cash sitting on corporate balance sheets. Record low yields are a function of the record low interest rates that we have seen for several years now.
The second reality is that just because the index yields are now around 5.5%, it doesn’t mean that is all that is available in the market. Yes, there is a huge portion of the market trading at massive premiums to par, and even big premiums to the bond’s call price, producing very paltry yields for investors. This is what is known as negative convexity, and is especially true of many of the large, on-the-run names that are widely held by the massive funds in the high yield market.
These funds need product, and are just grabbing what they can, irrespective of value and yield. However, there is also a sizable portion of the market that is trading at high single and low double digit yields. These aren’t all companies that have unsustainable balance sheets, tight liquidity, or about to default; rather, these are for the most part decent businesses that just don’t hit the radar screens of the large players because the tranche sizes may not meet the minimum thresholds set by some funds or they may just not be widely covered by the Wall Street analysts (and keep in mind analyst coverage doesn’t necessitate liquidity).
So for everyone who tells us that there is no yield available…work harder. Just like anything in life, the most reward is gained by working hard and not cutting corners. As active managers, that is just what we do at Peritus. We don’t just embrace the popular Wall Street recommendation, jumping into the same overvalued trade as everyone else, but instead scour the investment universe to find attractive value. The high yield market still offers plenty of yield for those managers willing to do the hard work to find it.