La Française: Overall quality high yield bonds is improving

La Française: Overall quality high yield bonds is improving

22 juni 2023

Obligaties
Obligaties (03)

The overall quality of High Yield issuers, both in the US or in Europe, is better today compared to previous economic cycles.

This however is not the case for the leveraged loans market, namely in the United States where issuers have undergone significant downgradings over the past months; the number of issuers rated CCC has increased considerably, and we note a concentration in the technology and health sectors. The leveraged loans market in the U.S. has shown signs of instability since the beginning of the year reaching a 15-year high in the number of defaults of small companies.

The increased quality of the High Yield market and the associated lower default risk of issuers makes the asset class more resistant in the event of a recession. We anticipate an increase in default rates in the U.S., i.e. between 4.5 and 5% in 2023 versus 2.5% in 2022. Default rates should remain in line with the historic long-term average and well below default rates observed during the 2001 and 2008 financial crises when default rates skyrocketed beyond 15%. In Europe, we also anticipate an increase in default rates. We expect to end the year around 3.5% versus 1.5% in 2022. Overall, the financial health of HY issuers, in Europe and the U.S., is improved relative to previous cycles.

Preferred durations, sectors and regions

Today, given macroeconomic uncertainties, we favor defensive sectors such as services, telecom, food and health. We remain very cautious with cyclical sectors such as manufacturing industry, retail, commodities, consumer cyclicals, etc. Small companies with weak operating margins will likely suffer from increased financing costs. Additionally, those sectors that benefited from accommodative monetary policy over the last decade (i.e real estate in northern Europe) will also suffer from higher rates and the slowing economy, especially heavily indebted companies.

In terms of geographic exposure, we favor the United States and Europe. We do not consider valuations for emerging markets to be of interest, especially in light of the associated risks. We anticipate a bigger increase in default rates in emerging markets relative to the rest of the world.

In terms of duration, the curve is relatively flat. We favor bonds with a four to six year duration which offer what we consider a good carry and potential roll down return.

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