The term ‘high yield tourist’ has been used to describe investors that dabble in high yield bonds for short periods of time but then exit. However, fund flows have been on an upward trajectory since 2014, so could these tourists now be considered permanent residents, asks LaRusse.
We are starting to think that in this low-yielding environment investors are trying to find the ‘safest’ way to get decent yield. The high yield market is made up of around 300-400 companies in Europe and over 1,000 companies the US, she adds.
Source: Barclays Capital, as at February 2017, for illustrative purposes only
“Historically high yield has been deemed to contain a lot of new-fangled, unfounded businesses, which is why people have been nervous of it. The US market does to this day have more high tech issuers than Europe, where they tend to be industrials. The earliest high yield issuer I could find in Europe was a Swiss toilet manufacturer – Geberit in 1997.
“The European high yield universe did not get larger until the euro currency was in existence. Over time, when you look back to what have been the biggest issuers in the sub-investment grade space, energy businesses and basic industrials feature highly. They are also highly cyclical and therefore require constant refinancing.”
She says investors concerned about the impact of interest rate rises on high yield are worried about the wrong thing. “While a rate hiking cycle in the US might affect other areas of the fixed income universe, the high yield market basically ignores rate hikes unless they are sharp and steep, which would cause a recession and therefore increased defaults. So there is no historic correlation,” she explains.
Monthly return correlations since 1984: US HY
Source: Bloomberg, as at April 2017
Monthly correlations in a hiking cycle
- Three periods where rates were in a rising cycle
- • 1993-1995
- • 1999-2000
- • 2004-2006
- Correlations were 0.15, 0.20 and 0.28 respectively
Source: Bloomberg, as at April 2017
Instead, high yield investors should look more at the economic environment and ask what the health of it is.
Says LaRusse: “On the whole, we think, pretty good. The US is in good shape, particularly if you are running a small business. Brexit negativity will cause nerves in Europe but the ECB should be thinking about increasing rates at some point. High yield is all about where you are in the growth cycle, so if you are fairly optimistic on growth you should be fine.”
In terms of defaults, in 2016 these were all about energy supply and demand. LaRusse says the imbalance in oil and gas has since fallen off and commodity prices are more on an even keel. “So we are probably going to see the default rate come down in 2017 as the high yield space is seeing leverage fall. This is different from investment grade, which is seeing increasing leverage at the moment.”
Source: Credit Suisse Credit Outlook 2017. For illustrative purposes only.
However, in Europe this also means issuance has been coming off a little bit recently as a lot high yield businesses have refinanced already due to rates being so low.
In the Global Short Dated High Yield Bond strategy managed by Insight for BNY Mellon, LaRusse says the main concern is to know their exit strategy from an investment.
“How do they plan to pay you back? Through a bank loan, a company IPO or issuance of shares, will they issue a new bond, or sell assets? There are variable ways to get our principle back.
“We think the smartest way to invest in high yield is high conviction, best ideas. We have a cash benchmark (3-month USD Libor) because we want to incentivise a capital preservation mindset. We believe you have the highest visibility of getting your money back if you are in the short-dated end of the market.”
Warning signs for a less favourable default environment:
- Drop in share price/enterprise value
- Complicated corporate structure
- Where is cash held and what’s it invested in?
- Serial acquisitions
- Poor corporate governance
- Senior staff turnover
- Financial policy – too much debt too short term
- Drawing down on revolving cash flow facility
Important Information
The value of investments can fall. Investors may not get back the amount invested. For Professional Clients.This is a financial promotion and is not investment advice.Any views and opinions are those of the investment manager unless otherwise noted. For further information visit the BNY Mellon Investment Management website: www.bnymellonim.com. INV00741 exp 04/08/2017