by Sloane Ortel and Martin Fridson, CFA, CFA Institute
The standard joke about high-yield bonds is that they’re not high yield any longer.
People started to tell that joke when the high-yield index fell below 10%. They’ve continued revising it as the index has moved steadily downward to its present 6%.
So let’s replace it with a much better joke: A bond manager has to appear in traffic court for a moving violation. The judge asks, “Don’t you know what ‘yield’ means?” The bond manager replies, “It’s been so long since there’s been any, I’ve forgotten.”
The judge begins to lecture him: “It’s every citizen’s duty in our society to understand the laws and obey them. It’s a sacred covenant.” The bond manager interjects, “I didn’t understand that last part.”
This joke evoked a chuckle from the audience at CFA Society New York’s 28th Annual High Yield Bond Conference. Martin Fridson, CFA, has been organizing and moderating the event for its entire history, starting back “when government bonds were yielding 9% and a respectable high yield credit could be found yielding around 14%.” Attendees have come to expect a mix of quirky humor, tactical insight, and portfolio management wisdom.
Enterprising Investor and CFA Society New York hope to transmit healthy doses of each through this experimental format.
What follows are 13 charts interspersed with related commentary from panelists throughout the event. To be clear: These quotes are from 13 and 14 June 2018 at the CFA Society of New York. In most cases, the charts and commentary were offered at different times. Participants’ remarks have been edited for clarity, and many rich veins of discussion could not be included due to length considerations.
CFA Society New York has made videos and copies of the presentations available, but the best way not to miss out next year is to attend in person. CFA Society New York puts on many insightful programs and offers many opportunities to get involved.
- “The ability of companies to access the market [since the crisis] led to a large spike in B issuers. There are also a lot more rated issuers in total than 2009.” — Robert Schulz, CFA, managing director, corporate ratings, S&P Global Ratings
- “The investment grade market has grown 40% over the last four years. The HY market has shrunk since 2015, and its overall credit quality has improved.” — Riz Hussain, director, US high-yield credit strategy, Barclays Capital
- “Usually, things are never at the average. When defaults start spiking, they spike to double digits. A ‘non-recessionary’ average default rate for bonds is 2.3%. We don’t see anything at Fitch that leads us to believe the cycle is going to turn into a spike over the next year.” (Editor: Fitch’s work put the high-yield default rate at 1.8% in 2017.) — Sharon Bonelli, managing director, Fitch Ratings
- “There’s no question [default rates] are very low. People talk about this as ‘We’re in the 13th inning of a credit cycle.’” — George Varughese, managing director, Alvarez & Marsal
- “Our view is that money will be shifting from US to a more global situation over the next few years. Right now we’re getting to the unusual position where you don’t have a pickup from local EM into high yield. There’s an embedded view on the dollar, but that opportunity to swap into EM is a pretty compelling one from a total return standpoint.” — Henry Peabody, CFA, vice president, multi-sector portfolio manager, Eaton Vance Management
- “Almost one third of the market was expected to default during the credit crisis because of their near-term maturities. Most companies now want to extend their runways. [They] are going out five, six, seven years. When rates start rising, you wind up getting more tenders. High-yield companies withstand rising rates better than expected because of that.” — Anne Yobage, CFA, director/co-founder, SKY Harbor Capital Management
- “If you think about the financing cycle we’ve had this last few years, high-yield companies have built this incredible runway which means it will take some time for issuers to pay higher coupons. . . . I think the loan index coupon actually fell by 40 basis points this year. . . . [Rising interest rates] will certainly affect lower-quality issuers the most because they have more floating rate notes.” — Martha Metcalf, CFA, senior portfolio manager, Schroders Investment Management
- “The shift we’ve seen over the past year to the Fed not giving you a get-out-of-jail-free card, the ECB not backing down as Italy gets volatility. We’re more nervous about rates than others. We don’t see a 10-year Treasury north of 5% as crazy, and people are asking if there’s value in the front end, if a 2.5% two year is sucking attention away from other credits.” — Henry Peabody, CFA
- “If rates are going up because earnings are going up, most of the market will be just fine. From a total return basis, it gets back to bonds and what’s investable. High yield has a strong record of outperformance when interest rates are rising. Over the past 20 years, there have been 16 50 basis point hike cycles.” — Kevin Lorenz, CFA, managing director/portfolio manager, TIAA
- “This late in the cycle, you’re really down to the relative value argument. The opportunistic buyer has definitely stepped back. Fundamentals are supportive, technicals are in balance, but valuations are stretched here.” — Martha Metcalf, CFA
- What does a flattening yield curve mean? “The strongest relationship is between 2s10s and the 3yr forward default rate. So the oft-forecast crisis via rates is likely to happen in 2021.” — Riz Hussain
- “Right now, we have to defend the asset category. We’re at historical tights, so a lot of clients think there’s nowhere good to go from here.” — Anne Yobage, CFA