August 23, 2018
The high-yield market continues to experience bouts of volatility, despite a positive fundamental backdrop, on the back of concerns over the trade war the U.S. has initiated against its trading partners. The increasingly hostile trade rhetoric has created uncertainty over future economic growth, and markets have priced this in. Spreads have been range-bound since December 2017, though yields continue to rise.
Spreads ended the second quarter one basis point tighter from their level on March 30, with bonds delivering a 1.0 percent total return, as measured by the ICE Bank of America Merrill Lynch Constrained High-Yield index. Higher-duration BB-rated bonds continue to trail returns in lower-quality bonds with a 0.1 percent loss in the second quarter, compared to a 1.4 percent gain for B-rated bonds and a 2.6 percent gain for CCC-rated bonds.
Looking at fundamentals, positive earnings growth among high-yield corporate bond issuers has brought leverage multiples back inside 5x earnings, ending at 4.3x earnings as of the end of first quarter 2018. Interest coverage has also improved to 3.7x earnings, up from 2.0x earnings in 2016, the highest since 2014. Given these factors, the weakness in high yield is clearly not being driven by market fundamentals. In this type of environment, passive strategies may underperform as investors sell the most liquid names first. Indeed, non-exchange-traded fund (ETF) eligible bonds have been outperforming ETF-eligible bonds this year, according to Credit Suisse. There is a 1 percentage point gap in year-to-date returns between ETF- versus non-ETF-eligible names, highlighting a technical dynamic that is weighing on returns, and this difference is even more pronounced in lower-quality credit, where non-ETF-eligible CCC-rated corporate bonds have returned 2.7 percent more this year than ETF-eligible CCCs. We believe this dynamic highlights the value-add from active management because it is crucial to be more selective on corporate credit. We continue to view B-rated credits favorably in the current environment relative to other credit tranches because they have a better balance of credit and duration risks and continue to offer wider spreads compared to their own history than those of other rating categories.
Despite a positive fundamental backdrop, the high-yield market continues to experience bouts of volatility on the back of concerns over the trade war the U.S. has initiated against its trading partners.
Source: ICE Bank of America Merrill Lynch, Guggenheim Investments. Data as of 6.30.2018.
Increasingly hostile trade rhetoric has created uncertainty over future economic growth, and markets have priced this in. Spreads have been range-bound since December 2017, though yields continue to rise.
—Thomas Hauser, Senior Managing Director; Rich de Wet, Director
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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, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited, and Guggenheim Partners India Management. ©2018, Guggenheim Partners, LLC. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC.
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