High-Income 2017 Outlook: Rosy or Rough?
by Erin Bigley, Fixed Income, AllianceBernstein
So following the election, we think that the range of potential outcomes has really widened. What the market is pricing in, knowing that weâve got a Trump administration and a Republican Congress, is a pro-growth, moderate-increase-in-inflation type of environment, which is good for risk assets like high-yield bonds.
What is not necessarily being recognized or priced into the markets is the potential for a larger negative tail.
If things donât work out as rosy as currently priced inâand we see a geopolitical event or we see growth not picking up as we expectâthat downside tail could be much bigger.
And so what do you do in that environment? You do still want to lean into growth assets, risk assetsâlike high yieldâbecause the potential upside is still there, but you want to try to find ways to buffer the downside.
To us, that means shorten up your maturities and go higher quality. We have seen time after time that just taking those two simple steps, focusing on shorter maturities and raising the quality of a high-yield portfolio, can actually buffer the downside, giving you roughly two-thirds of the downside in a high-volatility environment, with about 80% or so of the upside.
The other thing that you can do within a higher-yielding portfolio is to think beyond just corporate high yield. Corporate high yield has been on a great tear so far this yearâitâs up about 15% for the year to date and itâs been rising largely on the back of lower-quality, energy-driven sectors.
At this point, itâs a great time to take a step back and think about whatâs the best strategy going forward? And we think looking beyond the corporate high-yield sector to other bonds that have high yields but are in different areas.
For example, the emerging markets have sold offâpretty meaningfullyâin the wake of the election, so weâve been adding some local-currency emerging-market bonds to the portfolio and actually keeping some unhedged currency, which provides you with yield in a different way from corporates and it gives you some nice liquidity, particularly in the currency.
The other thing that weâve been doing is to look to additional sectors, like the mortgage market in the United States. Now these arenât your low-yielding guaranteed agency pass-throughs. These are credit riskâsharing transactions, or CRTs. Theyâre issued by Fannie and Freddie, but they have some credit risk associated with them. But, accordingly, youâre being paid high-yield-like yields.
The other thing we really like about CRTs is that, number one, the fundamentals are solid. The US real estate market continues to improve, and so youâre tapping into a fundamentally improving sector. Also, theyâre floating-rate securities. So theyâre tied to a floating-rate one-month LIBOR. So in the environment that weâve seen of rising rates, these securities should be buffered.
Going into 2017, we think it still makes sense to have a bias within your fixed-income portfolio to be overweight growth assets, credit assetsâlike higher-yielding bonds.
But you need to be very focused and very selective on what types of high-yield bonds do you own. So you want to make sure youâre avoiding the lowest-quality sectors. You want to make sure youâre not going too far out in terms of maturities. You want to make sure that youâre not owning too much in the corporate-only sector and that youâre looking farther afield, whether that be through geographyâby looking to the emerging marketsâor looking to other sectors like securitizations, where weâre tapping into credit riskâsharing mortgage transactions.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.
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