High yield markets have endured a torrid time in Q1 2020, recording one of the worst quarters ever, and delivering negative returns not seen since the darkest days of the Great Financial Crisis according to Kames Capital’s head of high yield Thomas Hanson.
It could have been far worse, he says, if it was not for broad Central bank and government interventions which helped to partially shore up the markets and drive a risk rally into quarter end.
The global high yield market now offers an effective yield of approximately 8.5%, so does this mean it is a buying opportunity for investors? Valuations are certainly compelling but clear risks remain, Hanson adds, pointing out that although there have been very few times this century when investors can buy the market at these levels, and that subsequent returns have been very positive, there are plenty of reasons to be cautious at this point. High yield, given its idiosyncratic nature, will be defined by individual winners and losers so robust fundamental research is imperative.
‘Despite attractive headline valuations, we would point out that this crisis is quite unlike anything the market has experienced before, and that we are simply in uncharted waters in terms of the economic fallout. Clearly much depends on the length of time of the economic outage, and that is simply unknown at this point.’
The market has been much more positive in tone recently, and the downward pressure on high yield bonds has reversed, aided by more positive fund flows and investors deploying surplus capital at the margin, but Hanson believes there is a bifurcation in terms of where that cash has been put to work.
He says: ‘Defensive, higher quality BBs have been the main beneficiaries of the turn in risk sentiment, as they are effectively viewed as the survivors come what may, and are competitively sought after often making them very hard to find, whilst lower rated cyclical industrials are the laggards, as many investors still want to cleanse their portfolios of these types of credit, despite the more depressed level of valuation.’
Hanson adds that the action announced by the US Federal Reserve last week does have the ability to meaningfully change sentiment amongst investors. ‘The Fed have addressed one of the main potential challenges to the market in terms of being willing and able to buy fallen angels. They have also effectively pledged support for HY by offering to buy a small amount of HY ETFs and provide liquidity to smaller issuers under the Main Street lending facilities. This could meaningfully help out those issuers facing a liquidity crunch.’