Three Key Signals for U.S. High Yield | Lord Abbett
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Market View

We believe current trends in issuer defaults, debt refinancing, and ratings composition point to a healthy market.

Read time: 2 minutes

Three months ago, Market View looked at key trends for the U.S. high yield market.  We continue to receive questions from investors about the asset class, so we thought we’d offer a brief update on some important market signals as 2020 enters its final months.

  1. Defaults

One area that has been the subject of investor queries is defaults, given the volatility in the U.S. high yield market in March and April.  It appears that concerns about elevated defaults have eased greatly. In October, two issuers have defaulted so far (through 10/29) with the volume of debt totaling $2.4 billion.1 This represents a sharp decline in the pace relative to prior months, with defaults totaling $9.5 billion, $6.7 billion, and $3.6 billion in July, August, and September, respectively.

In terms of the overall rate of issuer defaults, the current figure of 5.7% (as of September 30) is in line with the peak of the 2015-16 plunge in energy prices. Note that current default activity, like 2015-16, is largely restricted to the energy and retail sectors.

What about defaults in the context of the current U.S. economic environment? The current pace is about half that of prior recessions, which have tended to hit 10-12%. Further, the number of issues defaulting in 2020 (through October 29) is only about half the amount recorded in the 2009 downturn. The pace of defaults in 2020 is also below the levels of early 2000s and the great financial crisis of 2008-09. We believe this reflects the fact that the wave of defaults during the 2015-16 energy price rout removed some of the weakest credits from the U.S. high yield market.

  1. Refinancing Activity

More favorable borrowing conditions in 2020 have allowed U.S. high yield issuers to refinance their debt at lower rates and push out maturities, allowing these companies to shore up their balance sheets (see Figure 1).

 

Figure 1. The Torrent of U.S. High-Yield Issuance in 2020 Has Gone Mainly to Refinancing Existing Debt
Refinancing activity for the years 2010–2020 (through September 30)

Source: JP Morgan. Data as of September 30, 2020.

 

According to data from JP Morgan, less than 5% of outstanding U.S. high yield debt (including loans) matures through 2021. In our view, this means there is less of a potential default trigger with companies not being able to roll over debt.

  1. Ratings Composition

The overall credit quality of the high yield market has strengthened materially since the last U.S. recession (see Figure 2). Overall, the high yield market is the highest-rated it has ever been, according to data from ICE Data Indices. 

 

Figure 2: U.S. High Yield’s Credit Quality Profile Has Improved Materially Since the Last Recession
Composition of the ICE BofA US High Yield Constrained Index by ratings category for the indicated dates

Source: ICE Data Indices. Data as of September 30, 2020. BBB=Issues with ratings in the “BBB” category or higher. CCC=Issues with ratings in the “CCC” category or lower.
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.

 

To be sure, the current share of ‘CCC’-rated bonds in the ICE BofA U.S. High Yield Constrained Index is incrementally higher than the chart’s early 2000 starting point, at around 11% versus 9%. But since January 2000, ‘BB’-rated bonds have increased their share from 35% to 55%. Meanwhile, ‘B’-rated issues have seen their share of the index decrease from 55% to 33%.

A Final Word

Given what we believe is a healthy high yield market, we think this remains an attractive asset class for investors searching for yield in a global environment marked by ultra-low interest rates. Investors looking to add a high yield bond allocation to their portfolios may wish to consider a strategy employing a credit-focused active manager with deep research capabilities and a multi-decade track record in leveraged credit.

 

1Data on corporate defaults from Moody’s and JP Morgan.

 

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.

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 BofA 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 BofA 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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