Fundamentals support continued returns from global high yield bonds, says Aviva’s Todd Youngberg
Todd Youngberg, head of high yield investments at Aviva Investors, says that high yield bonds look attractive this year as long as expectations are adjusted from their exceptional performance in 2012.
2012 saw a record $365.7bn of global new issuance, with borrowers taking advantage of yields at all-time lows. Refinancing activity accounted for more than half of the total and this trend should continue to translate into robust issuance levels this year.
The supply of European high yield bonds is also picking up. We expect companies to increase leverage, taking advantage of the low cost of debt relative to equity. Uncertainty has declined enough that even conservative companies will feel comfortable increasing their debt levels. Having dealt with upcoming liabilities, we believe company default rates are set to remain low for some time. And while the potential for capital appreciation is limited, in our view high yield’s income generating ability retains a strong appeal for investors.
Importantly, security selection will be key to performance this year. The momentum in ratings migration is likely to continue its downward trend. While at the lower end there is probably still some room for spread compression, there is not much room for prices to go any higher, especially given the callable nature of the asset class.
We favour the single B segment of the spectrum, in addition to cyclical securities which are likely to benefit from a more stable economic environment. But while immediate risks from the European sovereign debt crisis and US fiscal cliff negotiations have been dampened, they should not be ignored. Austerity measures, particularly in Europe, will likely remain a drag on economic growth and there is still a significant risk of contagion from the eurozone sovereign debt crisis.
While we are not expecting significantly higher interest rates, we are still relatively cautious on longer duration BB-rated bonds given their expected increase in interest rate sensitivity from tightening spreads. Also, we are finding select opportunities in CCC-rated bonds, but are more cautious on names that present secular challenges within their business, most notably among the more distressed issuers.