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Fixed Income
5 reasons to invest in US high yield corporate bonds
Shannon Ward
Fixed income portfolio manager
Peter Becker
Investment Director
KEY TAKEAWAYS
  • High yield is a growth sensitive asset class, which should continue to benefit from a positive global growth backdrop.
  • Fundamentals are improving with leverage ratios beginning to decline and an upward upgrade/downgrade ratio momentum.
  • The shorter duration of the high-yield bond market versus investment grade may help insulate it from rising interest rates.
  • The US high-yield market continues to evolve. Today’s market is bigger, more diverse and higher quality — but also lower yielding.
  • Absolute valuations reflect a benign environment, but caution is warranted and selectivity remains key.

1. High yield is a growth sensitive asset class


The high-yield market has historically produced positive results over a full cycle, but it tends to do particularly well during the recovery phase of the business cycle as default rates fall, spreads tighten from wide levels and volatility trends lower. Credit metrics start to recover in this phase with high yield issuers working to repair their balance sheets. They also generally benefit from the economic uplift.


High yield bonds continue to do well in the expansion phase amid improving risk sentiment and credit conditions. As earnings rise, high yield issuers become safer and default rates decline.


Consensus projections indicate robust growth for 2022 (as shown below) and although we expect them to be revised down into 2022, our Capital Strategy Research Group expects growth rates in core economies to remain above trend over the next 12 months, with the exception of China. Global growth forecasts are generally being revised down as China faces slower-than-expected growth this year, while the US rebound – boosted by fiscal expenditure in the first half of the year – has started to fade. Global manufacturing PMI surveys suggest continued loss of momentum, although they remain above 50 for now, suggesting continued economic growth. These growth dynamics should continue to bode well for high yield bonds.


Major market 2022 GDP forecast

Forecasts shown for illustrative purposes only

As at 8 September 2021. GDP: gross domestic product. Source: Bloomberg, Macrobond, Capital Group

2. Fundamentals are improving


While leverage is still elevated compared to pre-pandemic levels, leverage ratios are beginning to decrease. Meanwhile interest coverage ratios have been trending up.


As at 31 October 2021. Source: BofA Global Research

As a result, 2021 has seen high yield upgrades outpacing downgrades, indicating an overall improvement in credit quality. This has also been the case for rising stars compared to fallen angels1. A record amount of debt was downgraded from investment grade to high yield in 2020. Since then, fallen angel volume has been modest, laying the groundwork for rising stars to continue to outpace for several quarters.


Fallen angels and rising stars by par amount

Data as at 31 October 2021. Levels shown for US bonds. YTD: year to date. Sources: JPMorgan

Prior to the onset of COVID-19, high-yield default rates were very low. Since peaking at the height of the global financial crisis, they had generally remained below the historical annual average of just over 3%, with the exception of the period around 2015–2016 when a collapse in the oil price drove a flurry of defaults in the energy sector. Default rates spiked again in 2020 as a result of the pandemic, but have since declined to near historical lows as economies reopened and growth picked up. The default environment is expected to remain relatively benign as we go into 2022. Early projections for 2023 also suggest default rates should remain relatively low. In fact, should current trends continue, 2021 could record the lowest calendar-year default volume since the global financial crisis. Recovery rates have also improved significantly, thus limiting the overall magnitude of loss from defaults. At 43.2% over the last twelve months recovery rates for high yield bonds are now slightly above the 25-year annual average of 39.6%2.


 


1. Rising star: bond upgraded from high yield to investment grade. Fallen angel: bond downgraded from high yield to investment grade.


2. As at 31 October 2021. Source: JPMorgan


 


Risk factors you should consider before investing:

  • This material is not intended to provide investment advice or be considered a personal recommendation.
  • The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment.
  • Past results are not a guide to future results.
  • If the currency in which you invest strengthens against the currency in which the underlying investments of the fund are made, the value of your investment will decrease. Currency hedging seeks to limit this, but there is no guarantee that hedging will be totally successful.
  • Depending on the strategy, risks may be associated with investing in fixed income, emerging markets and/or high-yield securities; emerging markets are volatile and may suffer from liquidity problems.


Shannon Ward is a fixed income portfolio manager with 29 years of industry experience (as of 12/31/21). She holds an MBA from the University of Southern California and a bachelor's degree in psychology from University of California, Santa Barbara.

Peter Becker is an investment director at Capital Group. He has 25 years of industry experience and has been with Capital Group for three years. He holds a master's degree from The Ingolstadt School of Management. He also holds the Chartered Financial Analyst® designation. Peter is based in London.


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Past results are not a guarantee of future results. The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment. This information is not intended to provide investment, tax or other advice, or to be a solicitation to buy or sell any securities.

Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. All information is as at the date indicated unless otherwise stated. Some information may have been obtained from third parties, and as such the reliability of that information is not guaranteed.