High Yield Market Default Update
By Heather Rupp, CFA, Director of Communications and Research Analyst for Peritus Asset Management, Sub-Advisor of the AdvisorShares Peritus High Yield ETF (NYSE Arca: HYLD)
As we stand today, default activity year-to-date has already surpassed the par default level for all of 2015. However, the defaults remain almost entirely in the commodity sectors—Energy and Metals/Mining—while outside of these segments, default rates remain at or near record lows. Energy and metals and mining together comprise about 20% of the market, so this leaves about 80% of the market where we continue to see a very benign default environment. Putting numbers to this, JP Morgan is reporting a total par-weighted US high yield bond default rate of 4.7% (including distressed exchanges), but excluding commodities, this default rate falls to a mere 0.5%.1
As we have spoken about before, we see the double edged sword with energy—it is both an opportunity and a risk. For the indexes, we are seeing a big spike and multi-year highs in defaults due to the high yield market’s large energy exposure. But within the energy sub-segment, we also continue to see selective opportunities for investment and have been active in a number of names that we believe offer value and are positioned well, even in the current pricing environment and going forward. While we would expect that we are nearing the peak on energy defaults and thus total default rates, we continue to expect default rates to remain elevated versus historical numbers as energy producers and service companies contend with low oil prices and we continue to caution investors that we believe an active approach, whereby the company’s fundamentals, hedging, breakeven points, and production location are assessed, is the best course of action for investment in this sector.
Then that leaves the remaining 80% of the high yield market. While this market has had strong returns so far this year, we still believe there is room to run. We believe the low default rate in this segment of the market is reflective of the generally solid fundamentals and reasonable capital structures we see for many of the issuers. Again, we believe an active approach is still the way to operate in the broader high yield market as well, as you look at both a company’s fundamental prospects relative to the current bond price/yield level. As we do this, we are seeing areas of value and real yield potential in the high yield market as we move forward.
1 Acciavatti, Peter, Tony Linares, Nelson R. Jantzen, CFA, Rahul Sharma, and Chuanxin Li. “Credit Strategy Weekly Update,” J.P. Morgan North American Credit Research, July 15, 2016, p.1.