A Bid for Lower Quality Re-Emerges

Market weakness offers attractive entry points in B-rated bonds, particularly in the energy sector.

May 24, 2016

This sector report is excerpted from the Second Quarter 2016 Fixed-Income Outlook.

Initially headed for its worst quarter on record, the high-yield corporate bond market ended up posting its best first quarter since 2012, after a reversal in sentiment drove a risk-asset rally. New issue activity was down 54 percent on a year-over-year basis, largely due to weakness in the first eight weeks of 2016. March saw signs of life in primary markets, with issuance totaling $21.2 billion, well above January and February volumes of $5.9 billion and $9.4 billion, respectively. Based on the underlying trends at the end of the quarter, which continued into April, a bid for lower quality appears to have returned. The pickup in demand was also evident in the high-yield mutual fund and ETF net fund flows, which were positive $7.7 billion for the quarter.

High-Yield Bonds Rebound as Spreads Tighten

Risk aversion at the start of 2016 led to a 5 percent loss in the highyield corporate bond market in the first few weeks of the year. Highyield bonds appeared to be headed for their worst start on record, but rising oil prices, a weaker dollar, and dovish commentary by the Fed drove a turnaround in sentiment.

High Yield Bonds Rebound as Spreads Tighten

Source: Credit Suisse, Guggenheim. Data as of 4.18.2016.

The Credit Suisse High-Yield Bond index posted a gain of 3.1 percent in the first quarter of 2016 with spreads tightening by 5 basis points. All rating categories delivered positive returns, with BB-rated bonds, B-rated bonds, and CCC-rated bonds returning 3.5 percent, 2.8 percent, and 3 percent, respectively. While retail and metals were the best performing subsectors overall, the energy component of the Credit Suisse High-Yield Bond index returned 14.6 percent in March, its best monthly gain on record. CCC-rated bonds also delivered stellar performance in March with a 9.9 percent total return, their best single month since October 2011.

B-rated bonds continue to offer attractive value relative to other rating tranches. As the chart below shows, B-rated corporate spreads ended the quarter at 248 basis points above BB-rated bonds, well above the historical average. Investors should expect more volatility ahead, however, as we enter a seasonally weak period for risk assets overlaid with the potential for additional corporate defaults and fallen angels. Despite the expectation of higher volatility, we expect to use market weakness to find attractive entry points in energy bonds. A stabilizing oil market in the second half of 2016 should pave the way for energy bonds to perform well over the course of the next 12–24 months.

B-Rated Bond Premiums Look Attractive Relative to BB-Rated Bonds

B-rated corporate bonds have historically offered spreads 200 basis points in excess of BB-rated corporate bonds, on average. This premium widened to 330 basis points in the first quarter of 2016, making B-rated bonds look relatively attractive. From the peak to the end of the first quarter of 2016, B-rated bonds outperformed BB-rated bonds by 1.5 percent on a total return basis as the spread differential narrowed to 248 basis points.

B-Rated Bond Premiums Look Attractive Relative to BB-Rated Bonds

Source: Credit Suisse, Guggenheim. Data as of 3.31.2016.

—Thomas Hauser, Managing Director

Important Notices and Disclosures

This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. It contains opinions of the authors but not necessarily those of Guggenheim Partners or its subsidiaries. The authors’ opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is no guarantee of future results.

Investing involves risk. In general, the value of fixed-income securities fall when interest rates rise. High-yield securities present more liquidity and credit risk than investment-grade bonds and may be subject to greater volatility. Asset-backed securities, including mortgage-backed securities, may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity risk. Investments in floating-rate senior-secured syndicated bank loans and other floating-rate securities involve special types of risks, including credit risk, interest-rate risk, liquidity risk and prepayment risk.

Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Real Estate, LLC, Transparent Value Advisors, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited and Guggenheim Partners India Management.


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