A Quick Read on Key Trends in U.S. High Yield | Lord Abbett
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Institutional Perspectives

Here’s a brief summary of Lord Abbett expert views on high yield valuations, supply/demand factors, and credit quality.

Read time: 2 minutes

With the remarkable resurgence in the U.S. high yield market since March’s volatility, we continue to receive inquiries from investors about key characteristics of the asset class. We’ve put together a brief summary of recent commentary from Lord Abbett experts.

Valuations
High yield spreads have recovered 60% from the widest levels of late March, based on the ICE BofA U.S. High Yield Constrained Index. As of June 30, the spread of the index was 497 basis points (bps), a significant improvement from the 1,087 bps spread recorded on March 23. Even with the strong recovery, we believe there is still room for spreads to tighten further.

 

Figure 2. High Yield Spreads Have Recovered Significantly Since Late March

Spreads on the ICE BofA U.S. High Yield Index, June 30, 1998–July 27, 2020

Source: ICE Data Indices, LLC. Yield spreads represented by the ICE BofA U.S. High Yield Constrained Index. Past Performance is not a reliable indicator or guarantee of future results. It is important to note that the high-yield market may not perform in a similar manner under similar conditions in the future. The historical data shown in the chart above are for illustrative purposes only and do not represent any specific portfolio managed by Lord Abbett or any particular investment. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment. Bps represents a basis point. One basis point equals 0.01%.

 

If we look at high yield spreads by rating, they are also still very elevated. Based on ICE BofA data, spreads for the ‘BB’ credit tier of the index are more than double what they were in late February 2020, and despite ‘B’ spreads tightening over 550 bps from their widest levels in March, they are nearly 300 bps wider than levels last seen in late February 2020.   

Supply/demand
There has been a record amount of new issuance as well as inflows in the high yield bond market. The $61 billion in new supply in June 2020 was the largest month on record, based on data from S&P Global, and the supply coming to market in the second quarter of 2020 was the largest quarterly figure on record. According to data from Lipper, April and May 2020 saw record flows into high yield funds (active and passive), while June was another historically strong month.

Credit quality
The high yield market is currently the highest-rated it has been in history. To be sure, the current share of ‘CCC’-rated bonds in the ICE BofA U.S. High Yield Constrained Index is incrementally higher, at 12% versus 9% in early 2000. But since January 2000, ‘BB’-rated bonds have increased their share from 35% to 56%. Meanwhile, ‘B’-rated issues have seen their share of the index decrease from 56% to 32%.


“Fallen angels” and default risk
We have been closely watching the growth of the so-called “fallen angels” category of high yield. It’s important to note that year-to-date through July 21, fallen angel volume has already surpassed previous record levels and that the trailing 12-month U.S. high yield default rate as of June 30 has risen to 6.19%, compared to average default rate of 3.21%, based on data from JP Morgan. However, fallen angels have historically provided alpha opportunity. When we look at prior cyclical downturns in the U.S. high yield market (2002, 2008, 2016), the ICE BofA U.S. Fallen Angel High Yield Index has materially outperformed ‘BB’ high yield bonds after spreads reached their peak.

 

Figure 2. “Fallen Angels” Have Outperformed the Overall BB Segment of U.S. High Yield After the Past Three Spread Cycle Peaks

Performance difference between the ICE BofA U.S. Fallen Angel High Yield Index versus the ICE BofA BB US High Yield Constrained Index for the indicated periods

Source: ICE BofA US Fallen Angel High Yield Index and the ICE BofA BB US High Yield Constrained Index.  The chart covers the 100 trading days following the widest point in the three expansions of high yield spreads in the past 20 years: October 11, 2002; December 19, 2008, and February 11, 2016.
Past performance is not a reliable indicator or guarantee of future results. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

 

Summing Up

Taking into account the current level of high yield bond valuations, the strong supply/demand dynamic, and the historically high credit quality of the market, we believe investors may wish to take a closer look at the U.S. high yield market, based on their level of risk tolerance. With the uptick in the default rate and the record amount of debt moving to “fallen angel” status, we believe active management can potentially play an important role in navigating the U.S. high yield market— and unlocking opportunities for alpha.

 

A Note about Risk: The value of investments in fixed-income securities will change as interest rates fluctuate and in response to market movements. Generally, when interest rates rise, the prices of debt securities fall, and when interest rates fall, prices generally rise. High-yield securities, sometimes called junk bonds, carry increased risks of price volatility, illiquidity, and the possibility of default in the timely payment of interest and principal. Bonds may also be subject to other types of risk, such as call, credit, liquidity, interest-rate, and general market risks. Longer-term debt securities are usually more sensitive to interest-rate changes; the longer the maturity of a security, the greater the effect a change in interest rates is likely to have on its price. Lower-rated bonds may be subject to greater risk than higher-rated bonds. No investing strategy can overcome all market volatility or guarantee future results.

Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that markets will perform in a similar manner under similar conditions in the future.

Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

This Market View may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

Treasuries are debt securities issued by the U.S. government and secured by its full faith and credit. Income from Treasury securities is exempt from state and local taxes.

Alpha is the excess return on an investment relative to the return on a benchmark index. 

basis point (bp) is one one-hundredth of a percentage point.

Fallen angels refers to bonds that have been downgraded from investment grade to speculative grade status.

Spread is the percentage difference in current yields of various classes of fixed-income securities versus Treasury bonds or another benchmark bond measure. Spread-to-worst measures the dispersion of returns between the best and worst performing security and is often linked to bond markets.

The ICE BofA U.S. High Yield Index is a capitalization-weighted index of all US dollar denominated below investment grade corporate debt publicly issued in the U.S. domestic market. The ICE BofA U.S. Fallen Angel High Yield Index (bonds downgraded from investment grade to speculative grade) is a subset of the  ICE BofA U.S. High Yield Index.

The ICE BofA U.S. High Yield Constrained Index is a rules-based index consisting of U.S. dollar-denominated, high yield  corporate bonds for sale in the U.S. The index is designed to provide a broad representation of the U.S. dollar-denominated high yield corporate bond market. The index is a modified market value-weighted index with a cap on each issuer of 2%. returns also look compelling on a risk-adjusted basis.

ICE BofA Index Information:

Source:  ICE Data Indices, LLC (“ICE”), used with permission. ICE PERMITS USE OF THE ICE BofAML INDICES AND RELATED DATA ON AN "AS IS" BASIS, MAKES NO WARRANTIES REGARDING SAME, DOES NOT GUARANTEE THE SUITABILITY, QUALITY, ACCURACY, TIMELINESS, AND/OR COMPLETENESS OF THE ICE BofAML INDICES OR ANY DATA INCLUDED IN, RELATED TO, OR DERIVED THEREFROM, ASSUMES NO LIABILITY IN CONNECTION WITH THE USE OF THE FOREGOING, AND DOES NOT SPONSOR, ENDORSE, OR RECOMMEND LORD, ABBETT & CO. LLC., OR ANY OF ITS PRODUCTS OR SERVICES.

The credit quality of the securities are assigned by a nationally recognized statistical rating organization (NRSRO), such as Standard & Poor's, Moody's, or Fitch, as an indication of an issuer's creditworthiness. Ratings range from 'AAA' (highest) to 'D' (lowest). Bonds rated 'BBB' or above are considered investment grade. Credit ratings 'BB' and below are lower-rated securities (junk bonds). High-yielding, non-investment-grade bonds (junk bonds) involve higher risks than investment-grade bonds. Adverse conditions may affect the issuer's ability to pay interest and principle on these securities.

Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett’s products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

The opinions in Market View are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. The material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy, and is not intended to predict or depict the performance of any investment. Readers should not assume that investments in companies, securities, sectors, and/or markets described were or will be profitable. Investing involves risk, including possible loss of principal. This document is prepared based on the information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

 

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