The opening months of 2023 have been something of a curate's egg for the global high yield market. January witnessed a truly monumental rally that surprised many with its ferocity, driven in no small part by the supportive technical environment. However, February's performance has been more circumspect as, among other things, rates markets have sold off and put pressure on total returns.
With the positive impulse from fund flows now diminishing (especially in US high yield), the market now finds itself in a slightly awkward spot. It is great to have that all-in starting yield of around 8.50% (even higher for one of our flagship funds), but you cannot deny that, when viewed through the lens of credit spreads alone, it is hard to make a bull case for further compression.
To put this into context, credit spreads were north of 650 basis points (bps) just a few months ago, before settling down to around 450 bps today (using the ICE BofA Global High Yield Constrained Index for reference). It depends on your assumption for average recoveries of course, but let's say that has gone from pricing in something close to a 6% default rate (which we would contend was undeniably cheap) to something nearer 3% (which we concede is perhaps nearer fair value).
So, where do we go from here? Well, the good news is with that high starting yield you still have an excellent platform to be able to deliver a positive total return from this point, just don't expect a sustained spread rally to add icing to that cake any time soon. Over the long term, global high yield has delivered some of the best risk-adjusted performance there is versus other asset classes, even relative to equities.
While the tactical case may not be as appealing as it was a few months ago, the structural case for high yield remains very much intact, as we illustrate on chart 1.
After all, as the saying goes, it is ‘time in the market' that counts more than ‘timing the market'.
And it is great to have the ‘high' part of high yield finally living up to its name.
Chart 1: 20-year asset-class risk vs. return profiles
Source: Bloomberg, MSCI and S&P. Reflects annualized total return and standard deviation (volatility) over a 20-year period to 31 December 2022. Based on daily returns hedged to USD. Includes the following indices: Bloomberg Global High Yield TR for 'Global High Yield'; Bloomberg Global Aggregate TR for 'Global Aggregate'; Bloomberg Global Aggregate Corporates TR for 'Global Corporates'; Bloomberg Global Inflation Linked TR for 'Global Inflation Linked'; Bloomberg Global Treasury TR for 'Global Treasury'; MSCI World TR for 'Global Equities'; MSCI Emerging Markets Total Return USD for 'EM Equities'; MSCI Europe TR for 'European Equities'; MSCI USA TR for 'US Equities'; and S&P Developed REIT TR USD for 'Global Dev. REITS'.
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