Bonds Commentary
Previous

Pass on Passive - In High Yield Anyway

April 2018

After holding up relatively well during the initial equity sell-off in late January/early February, high yield bonds finally succumbed to selling pressure over the back half of March, with the Bloomberg Barclays U.S. High Yield Index falling 0.60% during the month. It’s notable that the High Yield Index had fallen only 0.86% year-to-date through March, holding up far better than the -2.32% total return of the Bloomberg Barclays U.S. Corporate Index (investment-grade corporate bonds) and the -1.46% total return generated by the Bloomberg Barclays U.S. Aggregate Bond Index overall. Due to higher coupons/yields, high yield bonds have less interest rate sensitivity than their investment-grade brethren, leaving them relatively less impacted by oscillations or shifts in the Treasury yield curve. These bonds do carry either a below investment-grade rating or are unrated by Moody’s, S&P, etc., implying that issuers of these bonds are often in some manner of financial hardship – hence, the higher yield to attract buyers. In the case of high yield bonds, issuers often have little margin for error, and an economic downturn, or simply stagnation, can weigh heavily on an issuer’s ability to make required interest payments, increasing the probability of default.

High yield bonds have had a strong multi-decade run, with the Bloomberg Barclays U.S. Corporate High Yield Index posting an annualized return of 8.39% from 1990 through the end of March. But it’s been far from smooth sailing at times. From the start of the Financial Crisis on February 27, 2007, the day Freddie Mac announced it would no longer buy risky subprime mortgages, through March 6, 2009, the bottom in the S&P 500 at 666 – just over 2 years – the High Yield Index posted an annualized -14.5% return. This is just one extreme example, but worthy of remembering nonetheless. Credit has been, and remains expensive, broadly speaking, making it highly susceptible at present to bouts of market indigestion surrounding risks of all ilk’s – geopolitical, economic, or otherwise – leaving us less than sanguine surrounding potential outcomes from index-linked exposures to the high yield space over the intermediate-term.

The first quarter was marked by short-term interest rates marching higher, while the belly and long-end of the yield curve spiked higher, then stair-stepped lower to end the quarter – ultimately culminating in a significant flattening of the yield curve. We took a look at the two largest high yield exchange traded funds (ETFs) – JNK and HYG – relative to the actively managed high yield peer group during 1Q18. With high yield bonds, broadly speaking, stacking up relatively well during the quarter versus investment-grade bonds, one might have expected index-linked vehicles to fare reasonably well, but that’s not the case. Both JNK and HYG finished the quarter in the bottom third out of a sample size of 194 funds, underperforming the peer group median return by 0.72% and 0.28%, respectively, despite charging lower fees than the majority of actively managed peers. We’ve long favored active management in the high yield space, and after a prolonged period of spread tightening, we believe an active approach is more crucial at this juncture to achieving a positive outcome than has been the case for some time. We maintain a neutral stance on high yield relative to our long-term strategic target due to the pick-up in yield, or carry, relative to investment-grade bonds, and our positive outlook on the U.S. and global economies leading to continued low defaults in the space. Investor sentiment and risk aversion can weigh heavily on high yield even when there is little/no underlying fundamental change. High yield investors should stay the course and avoid overreacting to news flow.

Source: Bloomberg, Morningstar

Next

On a scale from 1 to 5, with 1 being 'Not Good' and 5 being 'Excellent', how would you rate this article?

Press enter to submit your rating

Rate this Article

Use this form to provide additional feedback based on the rating you provided.

Thanks for Rating

Would you like to provide feedback?

Thanks for your feedback!

The content and any portion of this newsletter is for personal use only and may not be reprinted, sold or redistributed without the written consent of Regions Bank. Re¬gions, the Regions logo and other Regions marks are trademarks of Regions Bank. The names and marks of other companies or their services or products may be the trademarks of their owners and are used only to identify such companies or their services or products and not to indicate endorsement or sponsorship of Regions or its services or products. The information and material contained herein is provided solely for general information purposes. Regions does not make any warranty or representation relating to the accuracy, completeness, or timeliness of any information contained in the newsletter and shall not be liable for any damages of any kind relating to such information nor as to the legal, regulatory, financial or tax implications of the matters referred herein. This material is not intended to be investment advice nor is this information intended as an offer or solicitation for the purchase or sale of any security or other financial instrument. Any opinions expressed herein are given in good faith, are subject to change without notice, and are only current as of the stated date of their issue. Regions Wealth Management is a business group within Regions Bank that provides investment, administrative and trustee services to customers of Regions Bank.

Neither Regions Bank nor Regions Institutional Services (collectively, “Regions”) are registered municipal advisors nor provide advice to municipal entities or obligated persons with respect to municipal financial products or the issuance of municipal securities (including regarding the structure, timing, terms and similar matters concerning municipal financial products or municipal securities issuances) or engage in the solicitation of municipal entities or obligated persons for such services. With respect to this presentation and any other information, materials or communications provided by Regions, (a) Regions is not recommending an action to any municipal entity or obligated person, (b) Regions is not acting as an advisor to any municipal entity or obligated person and does not owe a fiduciary duty pursuant to Section 15B of the Securities Exchange Act of 1934 to any municipal entity or obligated person with respect to such presentation, information, materials or communications, (c) Regions is acting for its own interests, and (d) you should discuss this presentation and any such other information, materials or communications with any and all internal and external advisors and experts that you deem appropriate before acting on this presentation or any such other information, materials or communications.

Employees of Regions Asset Management may have positions in securities or their derivatives that may be mentioned in this report or in their personal accounts. Additionally, affiliated companies may hold positions in the mentioned companies in their portfolios or strategies. The companies mentioned specifically are sample companies, noted for illustrative purposes only. The mention of the companies should not be construed as a recommendation to buy, hold or sell positions in your investment portfolio.

This communication is provided for educational and general marketing purposes only and should not be construed as a recommendation or suggestion as to the advisability of acquiring, holding or disposing of a particular investment, nor should it be construed as a suggestion or indication that the particular investment or investment course of action described herein is appropriate for any specific retirement investor. In providing this communication, Regions is not undertaking to provide impartial investment advice or to give advice in a fiduciary capacity.

*Investment, Annuities and Insurance Products

  • Are Not FDIC Insured
  • Are Not Bank Guaranteed
  • May Lose Value
  • Are Not Deposits
  • Are Not Insured by Any Federal Government Agency
  • Are Not a Condition of Any Banking Activity