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.

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 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.

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.