One of the more notable changes in market structure in the post-crisis period has been the rise of retail holders of high-yield corporate bonds. While there were individual bonds and open and closed-end funds held by individuals pre-crisis, the high-yield corporate bond market has been one traditionally dominated by institutional investors like insurance companies and pension funds.
As yields have dropped post-crisis in both fixed income and equities, and exchange-traded funds have become an easier way to access the high-yield bond market, the influence of the retail investor has risen. Yields offered in the high yield bond market have risen incrementally through the first quarter of the year – a combination of higher rates and wider credit spreads. Given that many Seeking Alpha readers may be relatively new entrants into the asset class, I wanted to give ten quick facts on the market environment at the end of 1Q to frame valuation.
- The year-to-date total return for the Bloomberg Barclays High Yield Index is -0.86%. Leading HY bond exchange traded funds – the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA:HYG) and the SPDR Bloomberg Barclays High Yield Bond ETF (NYSEARCA:JNK) have returned -1.05% and -1.44%, including reinvested dividends, year-to-date.
- After this modest sell-off to start the year, the yield-to-worst on the High Yield index sits at 6.19% at the end of 1Q.
- The lowest historical yields for speculative grade bonds occurred in June 2014 when the index traded to yield a lowly 4.83%.
- The average price of securities in the High Yield Index is $98.69, indicating that the market, on average, is now trading at a modest discount to where the bonds were initially issued.
- The average option adjusted credit spread over Treasuries offered by the average high-yield bond is just 354bp.
- For reference, the post-crisis tight for credit spreads was 311bp, which occurred in late January 2018. High-yield bond spreads did trade as tight as 233bp in May 2007 as risky assets moved towards their cyclical peaks. At that time, the 10-yr Treasury yield was at 4.86%, so the high-yield bond market still traded with meaningfully more yield at that time despite the tighter spread.
- Spreads opened the year at 343bp, tightened by 32bp through January 26th, but have since widened by 43bp as market volatility has picked up.
- For those scoring at home, the High Yield market once again delivered positive returns in December and January, but has produced negative total returns in February and March. This is consistent with my Santa Claus theory on high yield bond performance, a bankable calendar effect.
- One can see the relationship between rates and performance by looking at the high yield market by ratings cohort. Year-to-date, the highest quality below investment grade ratings cohort – BB rated bonds – have underperformed, producing a -1.60% total return. Single-B rated bond (-0.55%) and CCC-rated bonds (+0.30%) have bested the index. Asset markets have been a little choppy over the past several weeks, but the lowest rated cohort has delivered the highest year-to-date returns.
- Historically, my preferred trade in High Yield Bonds has been owning BBs. While I still believe that the market frictions that cause BBs to trade wide for their risk will lead to long-run outperformance, with a current yield of just 5.09% and spread of 237bp, the highest-rated cohorts of the high-yield bond market still offers limited upside. With a modest underperformance year-to-date, this more rate-sensitive part of the high yield market could become increasingly interesting to investors as recently issued bonds begin to trade at discounts.
High yield bonds produced negative total returns in the first quarter of 2018. It was the first negative quarterly return by the asset class since 4Q15. Higher interest rates and modestly wider spreads may decreased high yield bond prices and increased offered yields. While the asset class is incrementally more interesting for retail investors, spreads are still on the tighter end of historical ranges. I hope putting the current market valuation in a historical context was helpful for Seeking Alpha readers.
Disclaimer
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