Why US high yield is well worth the bumps
By Bill Eigen, portfolio manager, JP Morgan Funds – Income Opportunity Fund
Investor risk sentiment has taken a battering and the US high yield market has the bruises to prove it, but the sector also offers tremendous value.
The case for US high yield can be thought of based on three considerations:
1) Valuations: US HY prices are very depressed, currently nearing where they bottomed out during the tech bust, creating an attractive entry point
2) Fundamentals: The underlying fundamentals for US high yield look very reasonable. Certainly it is true that leverage is higher than it was a few years ago, but this is only marginally the case. Interest coverage ratios are at record high levels, so companies have the ability to service their debt very comfortably
3) Technicals: Technical factors have really been the drivers of high yield price weakness in recent years. If we look at the patter of flows in and out of the sector, between 2010 and the midpoint of 2014, US high yield received tremendous inflows. But from that point to the middle of February of this year, nearly all of those flows had left. It begs the question of who is left to sell at this point? Much of the so-called high yield ‘tourist’ money seeking to pick up yield has now left the sector and been flushed out. As a result, we may see a number of crossover buyers from equities starting to come into the market.
Exposure to the struggling energy sector has unquestionably been an albatross for US high yield, but investors may be overestimating the impact of energy weakness on the broader high yield market.
Today the energy and commodities complex makes up about 12% of the US HY market index. If we looked at this a year ago, it would have been closer to 17%.