High Yield: Passing the Baton from Beta to Alpha
Global Head of Portfolio Construction and Strategy Adam Hetts talks to Seth Meyer and Tom Ross, portfolio managers on the high-yield bond strategies, about how with credit spreads gradually tightening, returns will likely become less about market direction (beta) and more about identifying individual opportunities (alpha).
Key Takeaways
- Credit spreads have taken a round trip, having widened dramatically at the start of the coronavirus crisis but have since narrowed significantly. A recovery should squeeze spreads tighter, but investors will need to rely more on identifying opportunities through good credit analysis and security selection.
- Effective vaccines should allow economies to reopen and earnings and cash flows to recover. This should accelerate as 2021 progresses, allowing balance sheets to begin to improve.
- Companies in the energy sector may have to run with more conservative balance sheets not just because the oil price may remain low, but also because the costs of financing are likely to rise as more environmental, social and governance (ESG)-led investors refuse to lend to these companies.
- Inflation is a potential concern. While modest inflation is often good for corporate revenues, the very low yields on government bonds means inflation may cause volatility in the underlying government bond market that could feed into volatility among corporate bonds.
Credit Spread is the difference in yield between securities with similar maturity but different credit quality. Widening spreads generally indicate deteriorating creditworthiness of corporate borrowers, and narrowing indicate improving.
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Duration measures a bond price’s sensitivity to changes in interest rates. The longer a bond’s duration, the higher its sensitivity to changes in interest rates and vice versa.
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Fixed income securities are subject to interest rate, inflation, credit and default risk. As interest rates rise, bond prices usually fall, and vice versa. High-yield bonds, or “junk” bonds, involve a greater risk of default and price volatility. Foreign securities, including sovereign debt, are subject to currency fluctuations, political and economic uncertainty and increased volatility and lower liquidity, all of which are magnified in emerging markets.
Environmental, Social and Governance (ESG) or sustainable investing considers factors beyond traditional financial analysis. This may limit available investments and cause performance and exposures to differ from, and potentially be more concentrated in certain areas than, the broader market.
Basis point (bp) equals 1/100 of a percentage point. 1 bp = 0.01%, 100 bps = 1%.
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C-0121-35924 12-30-22