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Posted by on Jun 21, 2017 in Investment Perspective, Market Insight, Peritus Asset Management, Uncategorized

Mid-Year High Yield Bond Market Default Review and Outlook

Mid-Year High Yield Bond Market Default Review and Outlook

 
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)

 

Coming off of a spike in total high yield bond default rates in 2016 due to a large number of energy, metals and mining, and other commodity related defaults, the expectation was for defaults to significantly ease heading into 2017.1

 

As we sat six months ago, the expectation was for defaults to be 2.5% in 2017 and 3.0% in 2018, versus a 2016 level of 3.6% (see our piece, “High Yield Default Rate: 2016 Review and 2017 Outlook”).  As we hit the midpoint for 2017, the LTM default rate has fallen to 1.3% as monthly default volume continues to trend downward.2

 

While some seem to be concerned about the impact of potentially higher interest rates on the high yield market, investors need to be aware that the biggest driver of spreads historically is not interest rates (interest rate risk) but rather the default rate and outlook (default risk).  As we look forward, the default rate expectations for full year 2017 and 2018 has fallen to 2.0% or lower versus an expectation of 2.5% for 2017 and 3.0% for 2018 six months ago.3

 

 

This puts the default rate and expectations well below the historical average of 3.3%.4
 
Credit/default risk remains at the core of spread movement and, as we look over the next 18 months, we believe that the benign default outlook bodes well for the high yield market. Even with the spread tightening we have seen so far this year, according to J.P. Morgan’s research, the implied default rate based on current spreads in the high yield bond market is 1.7% versus an actual default rate of 1.3%, or 1.77% if you include distressed exchanges, and an outlook of 2.0% or lower for the next couple years.5 So while some may argue that the high yield market is expensive based on the current spread level, in looking at the default rates and expectations, is seems reasonably valued.  Additionally, we believe that adding an effective active management overlay on top of this can help to further stem default exposure and potentially improve spread/yield value.

 

1Jantzen, Nelson, CFA and Peter Acciavatti, “JPM High-Yield and Leverage Loan Morning Intelligence,” J.P. Morgan North American Credit Research, 6/1/17, https://markets.jpmorgan.com/?#research.na.high_yield.

2 Jantzen, Nelson, CFA and Peter Acciavatti, “JPM High-Yield and Leverage Loan Morning Intelligence,” J.P. Morgan North American Credit Research, 6/1/17, https://markets.jpmorgan.com/?#research.na.high_yield.

3 Acciavatti, Peter, Tony Linares, Nelson Jantzen, CFA, Rahul Sharma, and Chuanxin Li, “Credit Strategy Weekly Update,” High Yield and Leveraged Loan Research, J.P. Morgan North American Credit Research, 6/16/17, p. 5-6, https://markets.jpmorgan.com/?#research.na.high_yield.

4 Jantzen, Nelson, CFA and Peter Acciavatti, “JPM High-Yield and Leverage Loan Morning Intelligence,” J.P. Morgan North American Credit Research, 6/1/17, https://markets.jpmorgan.com/?#research.na.high_yield.  Based on monthly LTM default rates from December 1998 through May 2017.

5  Acciavatti, Peter, Tony Linares, Nelson Jantzen, CFA, Rahul Sharma, and Chuanxin Li, “Credit Strategy Weekly Update,” High Yield and Leveraged Loan Research, J.P. Morgan North American Credit Research, 6/1/17, https://markets.jpmorgan.com/?#research.na.high_yield.

 

Although information and analysis contained herein has been obtained from sources Peritus I Asset Management, LLC believes to be reliable, its accuracy and completeness cannot be guaranteed. This report is for informational purposes only. Any recommendation made in this report may not be suitable for all investors. As with all investments, investing in high yield corporate bonds and loans and other fixed income, equity, and fund securities involves various risks and uncertainties, as well as the potential for loss. High yield bonds are lower rated bonds and involve a greater degree of risk versus investment grade bonds in return for the higher yield potential. As such, securities rated below investment grade generally entail greater credit, market, issuer, and liquidity risk than investment grade securities. Interest rate risk may also occur when interest rates rise. Past performance is not an indication or guarantee of future results. The index returns and other statistics are provided for purposes of comparison and information, however an investment cannot be made in an index.

david@mediaworksllc.com

The AlphaBaskets blog provides frequent market insight and commentary by AdvisorShares Investments, LLC, created by AdvisorShares and other leading active managers.  AdvisorShares Investments is an SEC-registered investment adviser and the investment adviser to the AdvisorShares actively managed ETFs. The views expressed on AlphaBaskets should not be taken as investment advice or a recommendation for any of the actively managed ETFs advised by AdvisorShares.

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