Displaying items by tag: high yield
The recovery has boosted the junk bond market as investors saw investment-grade bonds and government debt perform…see the full story on our partner Magnifi’s site
Despite the big losses in Treasuries, high yield bonds have been doing well, and according to Fidelity that seems likely to continue. Advisors could be forgiven if they are wondering “how?”. The answer is that the big reason bonds are losing is interest rate risk, and it so happens that high yield bonds have some of the lowest interest rate risk around because of their higher coupons and shorter terms. According to Adam Kramer, who managers Fidelity’s Strategic Income Fund, “an economic recovery may be on the horizon and the Fed may avoid tightening monetary conditions for some time”, which he says means the high yield market “could offer investors the best of both worlds in 2021”.
FINSUM: High yield bonds have the lowest exposure to the market’s major risk at the moment and also the upside of an economic recovery. The picture is bright.
Bonds are incredibly expensive right now, but despite this, they may keep going higher, says Goldman Sachs. The firm is specifically referring to high yield bonds, which are very pricey right now and have low spreads to Treasuries. For example, only 10% of high yield bonds currently trade with spreads above 5 percentage points above Treasuries, compared to 25% in November. This makes Goldman believe the easiest gains are already in the bag, but given that high yield bonds are sensitive to an improving economy and they have appreciated even while Treasuries have fallen, Goldman feels the asset class could be in for more appreciation.
FINSUM: This makes sense. It is also worth noting that historically speaking, high yield bonds have no correlation to the performance of Treasuries.
It is pretty easy to sum up what seems like it will be a forthcoming bull market in high yield bonds: “2021 will be the year of the upgrade”. That quote comes from Matt Brill, head of North America investment-grade at Invesco. Ratings agencies are reportedly on the cusp of upgrading between $100 bn and $300 bn of junk bonds to investment grade this year and next. Fund managers are trying to buy the bonds they think will be upgraded as such a move will cause a lot of arbitrary buying by index trackers.
FINSUM: There were huge downgrades last year as the pandemic wiped out prices in big parts of the sector. Now, with the economy resurgent, big upgrades look likely, which should give the whole asset class wings.
Until every recently (and even now), junk bond yields were historically low. This was not a surprise since Treasuries were also at historic lows. But the whole situation begs an important question—why are junk bonds so popular when their yields are so low? It seems like an abundance of risk with little return. The answer to the question is that “there is no alternative”. Many fund managers have mandates to invest in a minimum holding of bonds, no matter what their yields. Therefore, when that cash needs to find a home in fixed income, it naturally finds its way towards the highest-yielding bonds, even if those might be quite risky. This helps explains the huge decline in yields since March 2020 (from an average of 12% yield to under 4% in February).
FINSUM: “There is no alternative” (TINA), is the same explanation given for the big rise in equities since after the Financial Crisis, and even since the beginning of the pandemic. Frankly, the argument seems to hold water.