Senior Portfolio Manager, Tim Leary, reflects on the performance of high yield fixed income over the past 5 years and why he believes the asset class will continue to perform well in 2023 and beyond. (8 minutes)
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Hello everyone, welcome to the Navigator, RBC Global Asset Management's podcast on the U.S. Fixed Income Markets. I'm Jason Pasquinelli and joining me today in our virtual studio is Tim Leary, one of our senior portfolio manager on BlueBay's leveraged finance desk. Tim was kind enough to do our podcast back in July where we received a lot of interest in having you back, Tim. So thanks for joining us.
My pleasure. Thanks for having me.
And before we begin, Tim, I certainly want to congratulate the team on a recent milestone. The desk has been managing U.S. high yield assets through global portfolios since 2010, but recently hit its five year track record to the dedicated US strategy. Both have been able to raise meaningful assets in a strategy that's generally been tough in this environment. So just wanting to pass on the kudos to you and the team.
I appreciate it. The team and I are very proud of our performance and the trajectory for H1 growth. So glad to get out and tell the story.
Excellent. Well, hey, Tim, last time we connected in July to the second of what now has been for 75 basis point rate increases. Can you walk us through the current environment in the US high yield space?
Sure. So we are about 1% higher, 100 basis points wider in yield terms at an index level. So if you think about back to July, yields were closer to seven and three quarters. Today they're closer to eight and three quarters. Interestingly, the spread at an index level over treasuries isn't that much different. You're sort of in that 465, 475, depending on the day.
What that doesn't tell underneath is just how volatile spreads have been since July. We got down to a low four hundreds and we got back up to close to 600. And now it's settled down post-CPI. The environment now is very well bid and I expect that to continue into year-end because while there has been some pickup in new issue supply, there hasn't been anything near large enough to derail the market price action.
Excellent. Default rates are currently around 1.3%. That consensus is taking “the over” for 2023. Any thoughts on whether we'll see a meaningful uptick in defaults next year?
I don't know anybody that would take “the under”. It's hard to get much lower than 1.3. So yeah, I think that default rates are going to go higher. They really just don't have anywhere to go but up. But that's not really the story. I mean, you could see default rates triple and be back to close to their sort of long term average.
More important than that the high yield market has grown so much over the last three years that there are multitudes of bonds to choose from that are not going to default. And so from our perspective, earnings trends…we think they're going to slow.
We think that we're going to enter into a mild recession. It's probably, the most well telegraphed recession in the history of mankind. But be that as it may, we do think that you're going to see some earnings slowdown as the Fed manufacturers a financial conditions to tighten, and they manufacture that slowdown itself. But we don't think that is going to be something that in 2023 is going to cause a huge disruption to markets now.
And the reason for that is that in particular, over the next two years, there is about 6% of the market that has to get refinanced. It's a very, very small refinancing window. And so if you think about why companies default, they generally default because they can't repay their debt as it comes due. They can't afford to pay interest or there's some type of fraud.
And the market just is not in that place yet. So defaults are going to pick up. It's really not that big of a deal. And I think that as conditions improve, if broader market start to price in the end of rate hiking cycles, conditions will improve and that will actually smooth out. And I think defaults are going to be more of a 2024 or 2025 story.
Tim, your team is known for looking at risks holistically in order to make security decisions. Nay risks are you seeing right now that you think are being unappreciated by the market?
Look, I think double B, high yield bonds are grossly mispriced and very tight for what they are, particularly relative to where triple B investment grade is trading. I think that, by and large, the high yield market has clamored for double B risk because again, because of that consensus view that we're entering into a slowdown or a recession.
And so, it's hard to really lose investors when you're defensively positioned into a sell off. And the way to be defensively positioned is by owning BB's. The fact of the matter is you're just really not being compensated high enough of a return to own that at this point in time. So we favor single B's, senior secured B’s at that, but there are certainly pockets of value in the BB space.
I do think one of those areas is within banking, particularly European banks that issue bonds and dollars that you can you can find quite a bit of paper there that's well wide of the U.S. BB universe. And that's as much a function of the fact that there's more supply in banks generally, and the markets are very cautious on Europe.
You kind of address my next question, which is where you see value at this time, but we'd love to hear your thoughts on valuation. Generally speaking, we've seen spreads not necessarily blow out. You think that things are fairly priced right now or do you think that there's going to be some movement in this space?
I think that post CPI and post the data this week, retail sales and the like that, you're going to see investors reengage with credit markets. The high yield market has been so incredibly unloved, credit markets more broadly have just been incredibly unloved and under allocated. And people are under- risked in that in that cohort. And so I think you're going to see investors reengage and deploy capital in the market. That is going to support levels, barring unforeseen near-term event.
So what is that a fair price? I think at the end of the day, you're getting paid 8 and 3/4 to own high yield, which is high enough to beat inflation in a low default environment. And about 53% of the benchmark is A and double B rated. So it's a safer benchmark than it was even three years ago.
And so I do think that is the market will come around to see value there. You know, leverage is at low multiples and interest covers is at high multiples, and that's a winning combination.
Excellent. Tim, while I want to get you back to the desk, so thank you so much for your time. We certainly appreciate your comments for the listeners out there. Certainly hope this podcast has been helpful. You can find this and future episodes of The Navigator at Institutional.rbcgam.com Thanks again.
Thanks, Jason.