Funds
Fonds
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As the economy rights itself after years of inflation and high interest rates, current market conditions offer a “solid foundation” for non-investment-grade bonds, says Dylan Herrmann, client portfolio specialist with Brandywine Global Investment Management.
Herrmann said there are still some inversion opportunities to be found in the high-yield market.
“Right now, a 7% yield for three years of duration in the asset class offers a compelling opportunity for most investors,” he said. “If you combine this with sub-par prices, strong fundamentals, a favourable supply-demand dynamic, and an improved market in terms of seniority and credit quality, you have a solid foundation for an allocation over the next few years.”
Herrmann said Fed easing cycles have historically supported longer-term positive performance for high-yield bonds, regardless of whether there is a hard or soft landing.
“This is an attractive opportunity for the high-yield market in general,” he said. “Looking at three-year performance from the first rate cut moving forward, high yield outperformed core fixed income in all periods, while also outperforming equities in hard-landing outcomes and delivering equity-like returns in soft-landing outcomes.”
He said large pools of institutional capital are starting to allocate to credit over the core fixed-income market.
“That’s leading to this supply-demand imbalance that we’re in right now,” he said, adding that credit markets have been in easing mode for some time now.
“We’ve seen strong issuance year-to-date, amidst high demand for both investment-grade and high-yield issues, which has also kept spreads relatively tight. We expect this trend to continue as strategic allocators are increasingly preferring credit exposure rather than Treasuries,” he said. “So, the opportunity in credit is definitely there.”
A slight caution, he noted, is that a spread over Treasuries that is near the tighter end of the historical range must be managed, but it’s not enough to offset the many positive factors he sees.
The trick, of course, is to find solid companies with good fundamentals. In particular, he looks for companies with attractive interest-rate coverage and historically low leverage levels.
“The idea here is that over the past few years, high-yield issuers have been preparing for higher interest rates and a potential recession, so they have been more conservative,” he said. “You’ve seen an improvement in the public high-yield market at a broad level, because a lot of the lower-quality issuers are now migrating to more aggressive financing markets such as private credit and leveraged loans.”
He said today’s high-yield bonds are not the so-called junk bonds of the 1980s.
“The majority of the high-yield market today is double-B rated. You’ve seen an improvement in quality since the global financial crisis,” he said. “We’re much more an improved market and migrating more towards investment-grade light, rather than being high yield.”
Herrmann said the latter half of 2024 was reasonably good for high-yield bonds, as risk markets sold off and safe-haven duration appreciated.
“High yield has outperformed core fixed income while simultaneously delivering less volatility,” he said. “Uncertainty around monetary policy and economic outcomes has fuelled higher interest rate volatility, thus leading to more volatility in longer-duration fixed-income asset classes, relative to high yield.”
As for where he sees opportunities, he’s taking a close look at industrials, where he’s found some new-issue single-B names that offer compelling yield opportunities in the high single digits.
“The other space that we’ve been looking at are non-bank financials,” he said. “In particular, we’ve been looking at the consumer lender space.”
He said that, following the regional banking crisis of March 2023, there was a perception that non-bank lenders would be under more pressure. Actually, they had less competition from traditional banks and were in a stronger position to lend money, while banks were tied up with regulation.
“Even with the recent interest rate cuts, we believe rates are still restrictive, and consumer debt levels are elevated,” he said. “Debt collection services are set to do well in this environment.”
He said keeping an eye on corporate fundamentals is crucial, though.
“Paramount in high-yield investing is steering clear of defaults, avoiding the potholes and driving straight on the path to success,” he said.
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This article is part of the Soundbites program, sponsored by Canada Life. The article was written without sponsor input.