Payden & Rygel: High yield fundamentals still intact
High yield bonds present opportunities for investors despite recent market volatility, according to Jordan Lopez, a director and high yield bond portfolio manager at Payden & Rygel. Here is an overview of his recent commentary on the asset class.
High yield fundamentals are solid
High yield companies are carrying only modest amounts of leverage, defaults are low, and rates remain elevated. Despite some volatility and worries about government policy, high yield remains attractive as an asset class. Moreover, high yield bonds are less vulnerable to defaults, which have historically triggered the end of an overperformance cycle.
The asset class is higher quality than in the past
Lower quality companies are now more likely to be financed with leveraged loans or private credit than non-investment grade bonds, making the high yield asset class, on average, higher quality and less vulnerable to defaults.
Liquidity is robust
The high yield asset class is more liquid than in the past, with a larger pool of institutional investors and the emergence of new trading platforms that allow for more transparency and more regular trading. In both quality and liquidity, the high yield market today looks more like the investment grade market than the junk market of the past.
Better downside protection than stocks
High yield bonds can offer improved downside protection relative to stocks because of their interest rate component. In non-inflationary environments, when investors are shedding risk assets like equities and spreads widen, rates typically fall. This can offset the effect of wider spreads and mutes price volatility in high yield bonds.
Elevated starting yields can suggest strong performance going forward
Starting yields for the high yield market currently stand in the mid-7% range. Yields have been a strong indicator of forward-looking returns. Over time, the historical correlation between forward five-year returns and starting yields has been about 0.93. Based on this correlation, we view the current yield environment to be an attractive entry point for high yield investors. Additionally, if alpha is added from active management, forward returns may approach expected equity returns, along with added downside protection, in our view.
