Chart of the Month | Beware of High Yield Bonds

January 8, 2021 |
2 minute read
|

Income-hungry investors continued to push yields on speculative grade bonds to new lows despite the challenging business conditions this year. The yield on the Bloomberg Barclays Corporate High Yield Index reached 4.18 percent on December 30th, the lowest on record, while the Bloomberg Bankruptcy Index remained at levels last seen during the economic slowdown in the first half of 2016.

The Bloomberg Bankruptcy Index measures the occurrence and severity of U.S. bankruptcy activity for corporations with at least $50 Million in reported liabilities. After hitting its post-GFC high in August, the Index has steadily declined as various fiscal and monetary programs supported businesses, while the gradual reopening of the economy during the summer led to a recovery in consumption. The Federal Reserve’s pledge to support the U.S. economy has also supported investors’ appetite for risk, allowing corporations to borrow record sums this year and making corporate balance sheets far riskier. According to the Securities Industry and Financial Markets Association (SIFMA), investment-grade and speculative-grade corporations issued $2.2 Trillion in total debt in 2020 as of November, a record annual level since 1996. Speculative-grade corporates alone issued $390 Billion, more than twice the combined amount issued in 2008 and 2009. The increase in borrowing has pushed leverage, the ratio of debt to earnings, to all-time highs, while the ability of some companies to support that debt has declined creating zombie companies where earnings don’t cover interest expenses.

Much of the borrowing went to increase cash levels, which reached $3.4 Trillion for companies in the S&P 500 Index, helping some of the hardest hit industries from the pandemic keep pace with this year’s equity market rally despite the increased insolvency risks. Bankruptcy rates are expected to pick up in the first half of 2021 as a result of a second wave of COVID-19 cases in developed economies where containment measures curtailed activity over the Christmas holidays. As a result, high yield option-adjusted spreads paint a less than compelling risk-reward picture at present. They have tightened significantly — consistent with much higher profit margins, a much stronger economic recovery, and higher Treasury yields — conditions that do not exist today. As a result, we continue to favor an underweight to high yield while our managers have reduced their credit overweights, allocating to mortgages and asset-backed securities over Treasuries. Within private credit allocations we prefer strategies that are focused on shorter-term corporate loans with strong covenants and first or second lien protection. We continue to see an attractive liquidity premium available to investors in private credit, particularly when gaining access through experienced managers with a demonstrated track record and proven work-out capabilities.

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Ivo C. Nenin

Author

Ivo C. Nenin

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Certain information contained herein has been obtained from or is based on third-party sources and, although believed to be reliable, has not been independently verified. Such information is as of the date indicated, if indicated, may not be complete, is subject to change and has not necessarily been updated. No representation or warranty, express or implied, is or will be given by The Common Fund for Nonprofit Organizations, any of its affiliates or any of its or their affiliates, trustees, directors, officers, employees or advisers (collectively referred to herein as “Commonfund”) or any other person as to the accuracy or completeness of the information in any third-party materials. Accordingly, Commonfund shall not be liable for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on any statement in, or omission from, such third-party materials, and any such liability is expressly disclaimed.

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To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated herein. Forecasts of experts inevitably differ. Views attributed to third-parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Market and investment views of third-parties presented herein do not necessarily reflect the views of Commonfund, any manager retained by Commonfund to manage any investments for Commonfund (each, a “Manager”) or any fund managed by any Commonfund entity (each, a “Fund”). Accordingly, the views presented herein may not be relied upon as an indication of trading intent on behalf of Commonfund, any Manager or any Fund.

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Disclaimer

Certain information contained herein has been obtained from or is based on third-party sources and, although believed to be reliable, has not been independently verified. Such information is as of the date indicated, if indicated, may not be complete, is subject to change and has not necessarily been updated. No representation or warranty, express or implied, is or will be given by The Common Fund for Nonprofit Organizations, any of its affiliates or any of its or their affiliates, trustees, directors, officers, employees or advisers (collectively referred to herein as “Commonfund”) or any other person as to the accuracy or completeness of the information in any third-party materials. Accordingly, Commonfund shall not be liable for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on any statement in, or omission from, such third-party materials, and any such liability is expressly disclaimed.

All rights to the trademarks, copyrights, logos and other intellectual property listed herein belong to their respective owners and the use of such logos hereof does not imply an affiliation with, or endorsement by, the owners of such trademarks, copyrights, logos and other intellectual property.

To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated herein. Forecasts of experts inevitably differ. Views attributed to third-parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Market and investment views of third-parties presented herein do not necessarily reflect the views of Commonfund, any manager retained by Commonfund to manage any investments for Commonfund (each, a “Manager”) or any fund managed by any Commonfund entity (each, a “Fund”). Accordingly, the views presented herein may not be relied upon as an indication of trading intent on behalf of Commonfund, any Manager or any Fund.

Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Fund. Such statements are also not intended as recommendations by any Commonfund entity or any Commonfund employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information or statements. Past performance is not indicative of future results. For more information please refer to Important Disclosures.