Letter to Investors - February 2013
High Yield Bonds Today
by Howard Marks, Chairman, Oaktree Capital
Clients often ask for our views on the high yield bond market: “Do we think prices are too
high?” “Are yields too low?” “What returns can we expect next year?” We caution them that
it’s nearly impossible to accurately predict these things, and anyone who makes such forecasts is
unlikely to be right.
These days the question is primarily whether high yield bonds are in a bubble and poised to
collapse, given last year’s strong performance and today’s historically low yields. We don’t
think high yield bonds are any more vulnerable to rising rates than other fixed income
instruments. We don’t downplay the risk in the market nowadays and the fact that bond prices
are quite high. However, the situation isn’t unique to high yield bonds; rather, it is true of
virtually all bonds and reflects the concerted effort on the part of central banks around the
world to hold down interest rates. Yields are at historic lows and prices are unusually high all
across the fixed income spectrum.
However, two factors argue strongly that high yield bonds are less vulnerable to rising
interest rates than other fixed income sectors:
• A high yield bond of a given maturity has a shorter duration than an investment grade
rated bond of the same maturity, since duration is a measure of the weighted average time
to receipt of the promised cash flows, and the larger interest coupons on high yield bonds
mean the expected payments from interest and principal are received sooner on average.
Thus an increase in interest rates of a certain amount implies less of a price decline for a
high yield bond than for an investment grade rated bond of the same maturity.
• In addition, rising interest rates usually imply a growing economy, and a growing
economy usually means improving creditworthiness and fewer defaults.
Of course it’s most unlikely that high yield bonds will deliver returns even close to 2012’s
performance. On the other hand, they don’t have to equal last year’s return to warrant
holding today.
Read Howard Mark's complete letter below or download here.
