An outlook for high yield bonds

The overall outlook for high yield bonds appears to be broadly positive.

Default rates remain low and economic data is encouraging. But the fortunes of the US and European markets are diverging, suggesting investors might consider a targeted approach rather than broad exposure to the asset class.

In the US, uncertainty over how many interest rate hikes are to come is leading companies to refinance and issue debt at an accelerating rate, leading to weakness in secondary markets. This has offset some of the gains since the beginning of the year.

There have also been significant outflows into the loan market, as loans are typically floating rate, meaning they will not suffer the negative impact of rising interest rates. These trends have opened up some opportunities for high yield investors, especially after a period in which it has been difficult to find investments at reasonable levels.

However, longer-term uncertainty for US high yield has been introduced by the withdrawal of proposed changes to US healthcare legislation, which has led to questions over President Trump’s ability to realise his other policy proposals. After his election late last year, high yield markets rallied significantly, based partly on his commitment to increase infrastructure spending.

Doubts over whether he can fulfil such promises have therefore introduced some vulnerability into the market.

In Europe, other factors are at play. There is uncertainty over forthcoming elections, but the European Central Bank continues to buy corporate bonds, driving investors to buy high yield bonds to maintain their potential for returns. As a result, it appears that demand and supply are relatively well balanced. The European market has outperformed relative to the US, but valuations are less attractive as a result.

Against this backdrop, focusing on short-dated high yield assets remains attractive. They are well placed to mitigate volatility associated with uncertainty, and offer low interest rate risk. They also offer a high degree of cash-flow visibility to help increase the probability of repayment.

Ulrich Gerhard is lead manager of the BNY Mellon Global Short Dated High Yield Bond Fund at Insight Investment

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