While volatility has recently increased in the high yield market, Neuberger Berman believes this has been largely driven by technicals, not a downturn in the underlying fundamentals that typically drive performance in the asset class. On a recent Whitepaper (15th August), they discuss the current fundamentals in the high yield market and its performance in different economic environments.
According to Dan Doyle, CFA, Portfolio Manager at Neuberger Berman, rate and political worries aside, conditions are supportive.
“After 10 consecutive months of posting positive returns, the high yield market experienced a setback in July 2014. Triggering this weakness, in our view, were technical factors—not a reversal in underlying fundamentals. More specifically, geopolitical issues in Ukraine, Gaza and Portugal, coupled with the Argentine bond default, negatively impacted investor sentiment. Adding fuel to the fire was robust second-quarter GDP growth that led to expectations that the U.S. Federal Reserve would tighten monetary policy sooner than previously expected. While geopolitical issues are likely to continue, we believe the high yield market experienced nothing more than a short-term correction and some profit taking—and we wouldn’t be surprised to see a fairly quick rebound”, explains.
Generally speaking, high yield performance is driven by fundamentals, such as defaults, as well as the direction of the overall economy. Against this backdrop, they believe that the high yield market remains healthy.
One of the reason is the strong corporate fundamentals. “While volatility has increased, we feel there are many reasons to remain optimistic about high yield. First, corporate fundamentals continue to be supportive, in our view, given generally healthy balance sheets, ample liquidity and cash flows that allow most issuers to handily meet their debt obligations. Against this backdrop, leverage in the overall U.S. high yield market remains modest at 4.1x (debt/EBITDA) versus 5.2x in 2009”.
New issuance is focused on refinancing
Many corporations have proactively capitalized on the current low interest rate environment to reduce their borrowing costs and extend their maturities. This is evident when looking at the charts below. In 2007, more than half of new issuance was used to fund aggressive actions, such as mergers and acquisitions and leveraged buyouts. Conversely, through the first half of 2014, 60% of new issuance has been used for refinancing.
Few bonds maturing—limiting default risk
Given the large amount of refinancing, a relatively small amount of high yield debt will be maturing in 2014 and 2015, minimizing pressure on borrowers. The high yield default rate has been—and we feel will continue to be—well below its historical average of 4% over the last 25 years.
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