Talking PointFeb 2 2023

Cautious optimism over high yield bonds

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Cautious optimism over high yield bonds
(Photo by ROCKETMANN TEAM via pexels)
ByIma Jackson-Obot

There is cautious optimism that high-yield bonds will perform better this year than they did in 2023, a fund manager said.

But, Kyle Kloc, a senior portfolio manager at Fisch Asset Management, added that the first six months of this year was set to be more difficult, with many companies having to cope with declining profits as a result of weak (or negative) economic growth and inflationary pressures. 

He said: “The good news: high yield bonds have never had two negative years in a row. Although we do not expect a huge rebound after an almost unprecedentedly weak 2022, we are cautiously optimistic that the historic pattern will remain in place in 2023.”

Kloc said he also expected spreads to widen in the first six months, before narrowing again in the second half of the year.

And while high-yield issuers still looked to be in a fundamentally good position, the situation was expected to deteriorate to some extent. 

Kloc added: “Although debt is unlikely to increase, a drop in earnings before interest, taxes, depreciation, and amortization (Ebitda) will lead to a higher debt ratio, while the rise in interest costs will impact free cash flow. We, therefore, expect default rates to climb this year – probably to around 4 per cent in the US and Europe.          

“In emerging markets, meanwhile, default rates should remain around 10 per cent, mainly as a result of further defaults in the Chinese real estate sector. A sharp rise in default rates does not appear to be on the cards, as the number of bonds maturing in 2023 is still relatively low.”

Being unable to repay or refinance debts that are reaching maturity is one of the main causes of default.

Saying that, overall, Kloc expects the market to be much less volatile in 2023 than in 2022, but he anticipates there will be greater disparity at the individual stock level, as the fundamental outlook for individual companies continues to diverge.

“Consequently, this makes security selection a more complex task. However, technical factors are likely to offer support. In the US in particular, the market is shrinking and therefore better able to cushion the impact of potential outflows," he added.

“We nevertheless prefer euro high yield bonds, as – for the same rating – they offer investors a higher spread than their US peers (and all the more so the lower the rating). In addition, the euro high yield market is rather more defensive overall because of its higher average rating and lower duration.”

In general, investors are expected to return to the high yield market, which has been the subject of significant outflows over the past two years.