Be Ready to Buy the High-Yield Dip, Not Sell the Rally
Author: Andy Kochar
February 3, 2020
The U.S. high-yield credit market may be due for a pullback after rallying significantly in 2019, but the asset class remains fundamentally sound, and cheaper valuations as the result of a sell off would likely be an attractive buying opportunity for investors.
The Barclays Global High Yield Index netted a return close to 13% last year as spreads between high-yield issues and U.S. Treasuries continued to tighten to record levels. The gains, especially of late, are the product of a cyclical upturn, which has also benefited stock markets, and further extends a mostly positive trend in high-yield performance since the beginning of 2017.
Given this backdrop, investors shouldn’t be surprised by the growing possibility of a near-term correction in high-yield prices. As with any type of asset, this is par for the course when valuations get overly stretched. But like many of the pullbacks in high-yield over the past few years, any future repricing should be bought and owned, not sold.
The market continues to be supported by corporate efforts to deleverage their balance sheets of public debt issues in favour of private debt and/or loans. This, in turn, has reduced the amount of public high-yield debt as a percentage of total corporate debt, improving supply and demand dynamics in the process.
It is also encouraging that the lowest quality (CCC-rated) high-yield issues have on average underperformed higher quality B and BB-rated issues over the past 12 months. This is a sure sign of a rational market that is still far from turning speculative.
That’s not to say the high-yield market isn’t without risks. For instance, if the riskier U.S. loan market were to falter, that could have an impact on high-yield valuations, given roughly 60% of high-yield issuers also have some level of loan exposure.
Certain sectors within the high-yield market, meanwhile, could begin to experience higher default rates by the end of this year and into next. In fact, some areas are already pricing in some form of distress, highlighting the importance of taking an active approach in this space. This is true, in particular, of companies in the resource sector and retail that don’t have the adequate access to capital needed to refinance and service existing obligations.
Ultimately, a broad pullback in the high-yield market should be viewed as a chance to buy into areas of the market that are expected to provide the best risk-adjusted returns going forward.
Andy Kochar is a Portfolio Manager and Head of Credit at AGF Investments Inc. He is a regular contributor to AGF Perspectives.
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