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Volatility Viewpoint – High Yield Bonds

GFX
Nicholas Leach
Vice President, Global Fixed Income,
CIBC Asset Management
“2016 was a great year for High Yield, actually outperforming equities. We were up around 18%, and those are market averages in general. Index ETFs actually underperformed by 250 to 350 basis points, and those index ETFs are structured to duplicate the market, and even these passive investment strategy structured to match the market  failed miserably in their mandate.”

GFX
2016 sector performance & volatility
“We had some sectors that were up double digits, and then some sectors that significantly underperformed, for example energy and metals and mining and the resource, those sectors were up big, again double digits, but the consumer space and the healthcare space significantly underperformed.

I think looking at the volatility between 2015 and 2016. We were down in 2015 by about 4.5, 5  per cent and then up 17, 18% % in 2016, but interestingly enough over the 2-year period the return is around 6%, roughly around 6%, and that is the same as the effective yield at the start of the 2-year period. So starting at the beginning of 2017, the effective yield for the market is around 5 ¾, 6% so that will give you an idea of least of what you would expect to earn over the next year, over the next two years, over the next 3 years. There might be some volatility in the short term around that 6%, but time and time again we’ve seen that on a rolling 2, 3 year period, high yield investors can expect to earn the coupon or the effective yield the beginning of the period.”

GFX
Historically low interest rates
“If we look at the way that the bond market performed in the latter part of 2016, there was a dramatic increase in bond yields in the fourth quarter, and we saw the U.S. 10-year treasury, which is the benchmark rate, go roughly from 1.4, 1.5% to 2.5, so that’s a huge move.

That’s still very, very low, in fact it’s around the same level as it was during the great financial crisis when there was this huge flight to quality, and at that time, rates were near record lows, so when you think of the back up of 100 basis points, it might seem like a lot over the past year but over the last 20 years, we’re still near historical lows. So when we look at the total returns during that period of rising rates, high yield actually posted a positive return, meanwhile investment grade corporates and obviously government bonds, they posted returns that in mid negative single digits just for one quarter.”

GFX
High yield default rates
“People think of the high yield market, they automatically think of defaults, now there are some defaults in the market, but it’s isolated to a very small area, and predominantly in the triple-C area. The default rate for double B’s in 2016 was zero, and so 80% of the defaults that occurred in 2016 were in triple C’s. For the most part, our focus, and our strategy and our philosophy is to always focus on the higher quality double B’s, single B’s where the default experience is dramatically different, and it’s unfortunate, again it’s a big misconception of the high yield market with the default because there is the a few bad apples that really spoil the whole bunch. We expect defaults to remain very low, the credit cycle is improving, interest coverage ratios are stable, debt levels are stable within the high yield space and we’re focusing on some areas of the markets such as telecom and healthcare. We stick with those companies that are going to continue to generate stable revenues, stable free cash flows regardless of what might happen in the broader, the broader geopolitical environment where you might see some risk off periods.”