Donald Phillips

A good entry point for high yield

Donald Phillips

History tells us this is a good time to buy high yield. High yield consistently displays resilience and good risk-adjusted returns versus equities: we like to compare the drawdown experience versus equities, for example, with the chart below showing the experience of the last decade plus.

14 discrete years Global High Yield vs equities

Indeed, while we are not calling the bottom in this current bout of volatility, the peak to trough fall in the S&P 500 (February into March 2020) to date has been around 20%, while the Global High Yield index has fallen close to 10%. The experience in Q4 2018 was similar as global high yield had a third of the drawdown of the S&P. Meanwhile, returns produced by the high yield sector compare well to equities.

All about the timing?

The chart above tells us high yield is an excellent long-term, strategic asset class, something we have written about before. In our experience, however, many investors look to time their allocation to high yield, waiting for an attractive entry point to make a tactical allocation. This begs the question of whether recent volatility has opened up such an opportunity.

Global High Yield spread

Only those with a crystal ball can know how Coronavirus and the nascent oil price war are going to impact markets in the coming months. But the near-term impact on global high yield, when measured by spread (the additional yield earned in top of government bonds), has seen a large spike to well over 600 basis points. Previous crises have seen spreads break through this level and, typically, this has represented an excellent entry point for medium to long-term investors.

For example, the table below shows the one and three-year returns for any investors who allocated to high yield when spreads had broken through 600bps. For anyone sceptical of the role energy sector bonds are playing in current valuations, we have also included an index that excludes energy and the lowest-quality bonds in the high yield universe (which has recently broken through 500bps spread level).

Global HY breaking through 600bps

One-year return (USD)

Next three years annualised

19/09/2008

9.1%

13.6%

05/08/2011

10.3%

9.8%

21/08/2015

9.9%

7%

 

US HY ex-CCC & Energy breaking through 500bps

One-year return (USD)

Next three years annualised

22/11/2007

-29%

9%

01/02/2013

6%

3.2%

07/06/2013

8.6%

4.8%

17/10/2014

2%

6.4%

02/07/2015

4.1%

5.1%

27/12/2018

16.6%

N/A

 

Source: Bloomberg, Liontrust

Only in the spread widening that occurred in 2007, as an early warning of the oncoming Global Financial Crisis, have investors experienced a negative return when investing in high yield from this kind of valuation entry point.

Over three years, that entry point went on to produce 9% annualised returns, which is better than the 7.5% average annual return of the global high yield market since 2006. An investor allocating to high yield in the midst of the 2013 ‘taper tantrum’ for example earned excellent returns over one year, though made pretty modest return over three years as they met the worst of the 2015/6 energy-based sell-off. For similar reasons, someone investing in late 2014 was not rewarded with strong returns over one year but was well compensated over three years.

A lot is being written elsewhere about the potential spread of Coronavirus and its economic impact. This is something we take seriously but also recognise our lack of expertise. With our high yield hats on, however, although there is huge uncertainty, history tells us this is a good time to invest in the asset class.

For a comprehensive list of common financial words and terms, see our glossary here.

 

Key Risks

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Investment in Funds managed by the Global Fixed Income team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The value of fixed income securities will fall if the issuer is unable to repay its debt or has its credit rating reduced. Generally, the higher the perceived credit risk of the issuer, the higher the rate of interest. Bond markets may be subject to reduced liquidity. The Funds may invest in emerging markets/soft currencies and in financial derivative instruments, both of which may have the effect of increasing volatility.

Disclaimer

The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Friday, March 13, 2020, 11:31 AM