This is also shown by the ‘recovery efficiency’ of high-yield bonds compared to equities, which is measured by looking at the drawdown period as a proportion of the recovery period. During the drawdowns of the past 30 years, the average recovery efficiency of US high-yield bonds has been higher than for equities.
High equity returns in recent years have been boosted by share buybacks, something that is unlikely to continue in the current environment. And if sectors are subject to state bailouts, they may be forced to suspend dividends. By contrast, central-bank support will help ensure that companies are able to pay coupons on time.
Our approach to investing in high-yield credit
At the international business of Federated Hermes, we are active, high-conviction credit investors and believe that in the current environment, a flexible approach to high-yield credit is more important than ever. Although policy support should reduce the number of defaults, active strategies will be better placed to assess which credits have the potential to withstand the turmoil.
As part of our investment process, we strategically allocate across different regions, ratings, parts of the curve, sectors, instruments and currencies. High-conviction, bottom-up security selection identifies attractive credits, while an emphasis on liquid, quality names lets us reallocate to take advantage of opportunities – such as those which are evident today.
The high-yield universe has globalised rapidly over the last 20 years and we believe that allocating capital to regions other than the US can help optimise a portfolio’s risk-return profile. Although the market crash is a global one, countries recover at different speeds and we believe our global outlook should help us diversify in the months ahead.
Our preference for large, multi-layered capital structures also means that our holdings are likely to have more funding options available to them – such as the ability of hybrids to issue public equity – and should also have stronger relationships with banks, which will put them in a better place to withstand any turbulence in the months ahead.
Finally, the coronavirus pandemic has emphasised the need to integrate environmental, social and governance (ESG) factors into credit analysis. Companies do not operate in a vacuum and during this volatile period it is important to find well-run businesses that do not face ESG-related risks. ESG analysis can help protect against the downside and is particularly important during market sell-offs.
Weathering the storm: seeking the upside in global high yield
We believe that the global high-yield market offers considerable opportunities in the months ahead. While defaults will likely tick up, the risk will be mitigated in part by central-bank stimulus and government support. Importantly, the obligation of high-yield credit to pay out coupons means it should recover more quickly and deliver returns earlier on in the macroeconomic cycle. In this turbulent and fast-changing environment, we will continue to take an active, flexible approach to seeking opportunities throughout the global high-yield credit spectrum.
