- U.S. Corporate defaults have jumped, but the default rate has been low for a very long time
- The market for lower rated companies' debt is much less efficient, so there’s more opportunity to differentiate and improve returns
- Especially over the long term, returns on high-yield bonds (BB/Ba and lower) can provide investors who are willing to take a little higher risk of loss a significant income boost
Well-known companies from Hertz, to Cirque du Soleil to U.S. department store giant, Neiman Marcus, are just a few that have recently filed for bankruptcy amid pandemic-induced lockdowns. With more bankruptcies on the way and sharply rising default rates, are high-yield investments worth the risk to your portfolio?
The good news is that decisive action by the Federal Reserve — including a corporate bond buying program means that a severe market selloff such as the one experienced in March is unlikely to return. And while no one can predict the future, high-yield bonds have held up well in the aftermath of previous recessions.
In the following Q&A, fixed income portfolio manager Shannon Ward shares her thoughts on the wave of bankruptcies and its impact on the U.S. high-yield bond market:
We’ve seen defaults in the U.S. triple from last year to a rate of 6.2%. What’s your expectation for the rest of the year?
The default rate has been very low for a very long time. The normal default cycle is around 3% per year, and it’s stayed below that level for multiple years. We are now seeing an upswing. I expect default rates to continue rising until next year. I wouldn’t be surprised if they hit the high single digits. As an active high-yield bond manager, that’s a big deal. I am trying to price and avoid defaults.
With COVID-19 shutdowns hitting businesses hard, companies have had to take on new debt, borrow on their revolving credit facilities and/or take advantage of government relief programs. But the longer the pandemic lasts, the more likely they will exhaust these pools of liquidity and be forced to negotiate a deal with their lenders or file for bankruptcy.