Michael Weilheimer, CFA Director, High-Yield Investments
Steve Concannon Portfolio Manager, High-Yield Investments
Jeff Mueller Global Portfolio Manager, Global Credit Analyst, High-Yield Investments
Will Reardon Institutional Portfolio Manager, High-Yield Investments
• High-yield bonds occupy a special capital market niche: They have offered better risk-adjusted returns than equities and lower interest-rate sensitivity than the broad fixed income market.
• To date, high-yield bonds have been less vulnerable to the adverse effects of rising rates than other fixed-income sectors and have provided positive total returns in rising rate markets.
• Adding high-yield bonds to a broad fixed-income allocation has improved portfolio efficiency, based on 10-year hypothetical performance of blended portfolios.
• Recent problems in the energy sector sparked a broad sell-off of high yield, resulting in value opportunities for investors with the expertise and diligence to select quality issuers.
Why allocate to high-yield bonds?
High-yield bonds occupy a special capital market niche. As obligations of companies with below-investment-grade credit ratings, they offer higher yields to compensate investors for accepting additional credit risk. Generally, the lower the bond rating, the higher the yield.
To date, high-yield bonds have offered better risk-adjusted returns than equities and lower interest rate sensitivity than the broad fixed-income market. Points to consider:
Better risk-adjusted returns than stocks
Over the past decade, high-yield bonds have produced essentially the same total return as stocks, with about two-thirds of the volatility, resulting in a higher Sharpe Ratio (see Exhibit A).
Lower interest-rate sensitivity than bonds
The high income stream from high-yield bonds helps lower their duration compared with broad investment-grade indices like the Barclays Global Aggregate Index and other fixed-income sectors. High-yield bonds have the highest yield per unit of duration of all sectors (except floating-rate loans, which yield less; see Exhibit B).
Positive performance in rising rate markets
Rising rates are often an indicator of a strengthening economy. Because high-yield bonds are proxies for the credit strength of lower-rated companies, bond prices often move in tandem with equities.
For example, over the 20 years ended 31 March 2016, during periods when five-year US Treasury yields gained 70 basis points (bps) or more in three months, high-yield bonds have averaged a gain of 2.5%, compared with a 3.0% return for the S&P 500 and a loss of 1.4% for investment-grade bonds, according to JPMorgan.
Even during the weak part of economic cycles, a diversified portfolio of high-yield bonds, like the JPMorgan Domestic High-Yield Index, has shown resilience. Over the past 35 years, the JPMorgan Index has had just five years with negative total returns, compared with seven for the S&P 500.1
Improving fixed-income portfolio efficiency
The unique attributes of high-yield bonds have resulted in performance with low correlation to other fixed-income asset classes. For example, Exhibit C shows that the Barclays US High-Yield Index has been just 0.37 correlated with the Barclays Global Aggregate Index. Only the lower-yielding floating-rate loan sector had lower correlation.
Exhibit D shows how over the past 10 years, adding 10% or 20% high yield to a Global Agg portfolio would have increased efficiency with improved performance and reduced volatility.
Opportunities in today's market
Concerns over sluggish global growth and depressed prices in the energy sector sparked a sell-off in the high-yield sector in 2015 that has carried over into early 2016.
As is often the case when broad market sentiment reaches a negative extreme, even bond prices of issuers with strong fundamentals have been driven below what we consider to be fair value, with a corresponding widening of spreads relative to US Treasuries.
As of 31 March 2016, the spread on the Barclays US High-Yield Index was 656 bps - 112 bps above its 10-year median.
The yield to maturity was 8.2%.
Exhibit E shows that among major fixed-income sectors, high-yield valuation on 31 March 2016 was the "cheapest," based on median spread levels, relative to its history and other bond sectors.
High yield has a history of strong rebounds
The history of high-yield bonds has taught us that patience is often rewarded. Exhibit F shows 31 instances since 1988 (when high-yield spreads were first tracked) through 31 March 2016 in which spreads were about as wide as they were on that date (plus or minus 50 bps)2. Annualised total returns for the three subsequent years ranged from 5.7% to 19.4%, with a median of 11.7%.
With high-yield defaults averaging about 2% over past 10 years and recovery rates of about 40%, exposure to credit loss would be about 120 bps per year on average.
That leaves a considerable total return cushion if the default rate rises in the coming year - something we expect, given that 15% of the asset class is exposed to the energy, metals and mining sectors.
Worries about the energy sector and credit quality that have helped drive the high-yield sell-off are legitimate concerns. However, the market is already discounting default rates that are several times the current level.
Eaton Vance's approach to high yield
The recent sell-off in high-yield bond underscores the need for professional expertise and due diligence across the entire credit cycle: the key to maximising potential return in the sector, while seeking to minimise volatility.
Eaton Vance has a 32-year track record of managing high-yield investments and delivering solid risk-adjusted returns. Our principal high-yield strategies rank in the top quintile of managers over 1-, 3-, 5- and 10-year periods, based on eVestment Alliance rankings as of 31 March 2016.
This track record has been achieved through:
• Continuity and consistency as hallmarks of our leadership and investment process
• Capitalising on inefficiencies in the high-yield bond market through rigorous fundamental credit research and market factor analysis
• Attention to risk-adjusted metrics and the goal of maintaining strong risk-adjusted returns throughout market cycles.
It would be our privilege to discuss with you how the Eaton Vance approach to high-yield investing may help your portfolio achieve its investment goals.
Index Definitions
Barclays US Aggregate Bond Index is an unmanaged index of US investment-grade bonds, including corporate, government and mortgage backed securities.
Barclays Global Aggregate Ex-USD Index is a broad-based measure of global investment-grade fixed-rate debt investments, excluding USD-denominated debt.
Barclays US Corporate High-Yield Index measures USD-denominated, noninvestment-grade corporate securities.
Barclays US Corporate Investment Grade Index is an unmanaged index that measures the performance of investment-grade corporate securities within the Barclays U.S. Aggregate Bond Index.
Barclays US Mortgage Backed Securities (MBS) Index measures agency mortgage-backed pass-through securities issued by GNMA, FNMA and FHLMC.
Barclays US Agency Index measures agency securities issued by U.S. government agencies, quasi-federal corporations, and corporate or foreign debt guaranteed by the U.S. government.
Barclays US Treasury Index measures securities issued by the US government.
S&P/LSTA Leveraged Loan Index is an unmanaged index of the institutional leveraged loan market.
S&P 500 Index is an unmanaged index of large-cap stocks commonly used as a measure of US stock market performance.
JPMorgan Emerging Markets Bond Index Plus (EMBI+) is a market cap-weighted index that measures USD-denominated Brady Bonds, Eurobonds and traded loans issued by sovereign entities.
JPMorgan Domestic High-Yield Index is designed to mirror the investable universe of the U.S. dollar domestic high-yield corporate debt market.
BofA/Merrill Lynch High-Yield Master II Index measures USD-denominated, noninvestment-grade corporate securities.
BofA/Merrill Lynch Indices: BofA/Merrill LynchTM indices not for redistribution or other uses; provided "as is," without warranties, and with no liability. Eaton Vance has prepared this report, BofA/Merrill Lynch does not endorse it, or guarantee, review, or endorse Eaton Vance's products.
Unless otherwise stated, index returns do not reflect the effect of any applicable sales charges, commissions, expenses, taxes or leverage, as applicable. It is not possible to invest directly in an index. Historical performance of the index illustrates market trends and does not represent the past or future performance.
About Eaton Vance
Eaton Vance is a leading global asset manager whose history dates to 1924. With offices in North America, Europe, Asia and Australia, Eaton Vance and its affiliates offer individuals and institutions a broad array of investment strategies and wealth management solutions.
The Company's long record of providing exemplary service, timely innovation and attractive returns through a variety of market conditions has made Eaton Vance the investment manager of choice for many of today's most discerning investors. For more information about Eaton Vance, visit eatonvance.com.
About EVMI
Eaton Vance Management (International) Limited (EVMI) is a subsidiary of Eaton Vance Management (EVM), a leading US asset management organisation, and markets internationally the investment capabilities of Eaton Vance Management and its affiliates, including Parametric Portfolio Associates, LLC. EVMI has been based in London since 2001.
This material does not constitute an offer or solicitation to invest in any Eaton Vance fund and/or products. Forecasts may not be attained. Past performance is no guarantee of future results. This material is communicated by EVMI, which is authorised and regulated in the United Kingdom by the Financial Conduct Authority and located at 125 Old Broad Street, London, EC2N 1AR, United Kingdom, Tel. +44 (0)203.207.1900.
EVMI is a wholly owned subsidiary of Eaton Vance Management (EVM). EVM is an investment advisor registered with the United States Securities and Exchange Commission (SEC) and is a wholly owned subsidiary of Eaton Vance Corp. (EVC). The nonvoting common stock of EVC, parent company of EVM, is publicly traded on the NYSE under the symbol "EV." For purposes of this material, "Eaton Vance" or the "Company" is defined as all three entities operating under the Eaton Vance brand.
EVMI markets the services of the following strategic affiliates: Parametric Portfolio Associates LLC (Parametric) is an investment advisor registered with the SEC and is a majority-owned subsidiary of EVC and Hexavest, which is an investment advisor based in Montreal, Canada, registered with the SEC in the United States and which has a strategic partnership with Eaton Vance, who owns 49% of the stock of Hexavest Inc.
In Singapore, EVMI has a wholly owned subsidiary, namely Eaton Vance Management International (Asia) Pte. Ltd. (EVMIA), 8 Marina View, Asia Square Tower 1, #07-05, Singapore 018960, which holds a Capital Markets License under the Securities and Futures Act of Singapore (CMS100185-1), is an exempt Financial Adviser pursuant to the Financial Adviser Act Section 23(1)(d) and is regulated by the Monetary Authority of Singapore. This document is to be distributed to Accredited Investors ONLY (as defined in the Securities and Futures Act, Chapter 289 of Singapore).
In Australia, EVMI is exempt from the requirement to hold an Australian financial services license under the Corporations Act in respect of the provision of financial services to wholesale clients as defined in the Corporations Act 2001 (Cth) and the Australian Securities and Investments Commission's Class Order 03/1099.
EVMI is registered as a Discretionary Investment Manager in South Korea pursuant to Article 18 of Financial Investment Services and Capital Markets Act of South Korea.
EVMI utilises a third-party organisation in the Middle East, Wise Capital (Middle East) Limited (Wise Capital), to promote the investment capabilities of Eaton Vance to institutional investors. For these services, Wise Capital is paid a fee based upon the assets that Eaton Vance provides investment advice to following these introductions.
The views expressed in this material are those of the authors and are current only through the date stated at the top of this page. These views are subject to change at any time based upon market or other conditions, and Eaton Vance disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Eaton Vance are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance fund.
This material may contain statements that are not historical facts, referred to as forward-looking statements. An investment's future results may differ significantly from those stated in forward-looking statements, depending on factors such as changes in financial markets or general economic conditions, the volume of sales and purchases of fund shares, etc. This material is for professional clients only.
©2016 Eaton Vance Management (International) Limited
125 Old Broad Street, London, EC2N 1AR, United Kingdom
Telephone: +44 (0)203.207.1900
E-mail: [email protected]
For orofessional clients ONLY. Not to be used with the public.
21244 5.16.16
