by Andy Kochar, AGF Management Ltd.
The U.S. high-yield credit market may be due for a pullback after rallying significantly in 2019, but the asset class remains fundamentally sound, and cheaper valuations as the result of a sell off would likely be an attractive buying opportunity for investors.
The Barclays Global High Yield Index netted a return close to 13% last year as spreads between high-yield issues and U.S. Treasuries continued to tighten to record levels. The gains, especially of late, are the product of a cyclical upturn, which has also benefited stock markets, and further extends a mostly positive trend in high-yield performance since the beginning of 2017.
Given this backdrop, investors shouldnât be surprised by the growing possibility of a near-term correction in high-yield prices. As with any type of asset, this is par for the course when valuations get overly stretched. But like many of the pullbacks in high-yield over the past few years, any future repricing should be bought and owned, not sold.
The market continues to be supported by corporate efforts to deleverage their balance sheets of public debt issues in favour of private debt and/or loans. This, in turn, has reduced the amount of public high-yield debt as a percentage of total corporate debt, improving supply and demand dynamics in the process.
It is also encouraging that the lowest quality (CCC-rated) high-yield issues have on average underperformed higher quality B and BB-rated issues over the past 12 months. This is a sure sign of a rational market that is still far from turning speculative.
Thatâs not to say the high-yield market isnât without risks. For instance, if the riskier U.S. loan market were to falter, that could have an impact on high-yield valuations, given roughly 60% of high-yield issuers also have some level of loan exposure.
Certain sectors within the high-yield market, meanwhile, could begin to experience higher default rates by the end of this year and into next. In fact, some areas are already pricing in some form of distress, highlighting the importance of taking an active approach in this space. This is true, in particular, of companies in the resource sector and retail that donât have the adequate access to capital needed to refinance and service existing obligations. In fact, some are already pricing.
Ultimately, a broad pullback in the high-yield market should be viewed as a chance to buy into areas of the market that are expected to provide the best risk-adjusted returns going forward. at the expense of the resource sector.
Andy Kochar is a Portfolio Manager and Head of Credit at AGF Investments Inc. He is a regular contributor to AGF Perspectives.
The commentaries contained herein are provided as a general source of information based on information available as of January 30, 2020 and should not be considered as investment advice or an offer or solicitations to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication however, accuracy cannot be guaranteed. Investors are expected to obtain professional investment advice.
The views expressed in this blog are those of the author and do not necessarily represent the opinions of AGF, its subsidiaries or any of its affiliated companies, funds or investment strategies.
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This post was first published at the AGF Perspectives Blog.
