A darling asset class of this bull market has been U.S. high yield debt, as many searching for income in a low-rate world have turned to these higher-yielding bonds. According to Bloomberg data, on an annualized basis through July 31, the Barclays U.S. High Yield two percent Issuer Cap Index has gained 14.9 percent since December 2008, trailing only the S&P 500 Index (up 16.1 percent) in performance.
However, with a Federal Reserve (Fed) rate hike on the horizon for later this year and universal acceptance that it’s late in the current credit cycle, some investors are considering abandoning the asset class. The fear is that outflows from high yield could continue, putting it under pressure, and some have even speculated that high yield debt may be the next “Big Short.”
Given all this, high yield may still have a portfolio role to play for investors. Here’s why.
1. There’s value there.
It’s hard to argue that high yield is cheap. Spreads (yield minus the yield of comparable U.S. Treasuries) are currently 575 basis points (bps), down from 1,930 bps in 2008, according to Bloomberg data.
But while high yield certainly isn’t cheap, the recent widening of spreads has returned some value to the asset class. Today’s high yield spread is still 135 bps above pre-2013 Taper Tantrum levels and 175 bps above the tightest post-crisis levels reached in June 2014, according to Bloomberg data. Looking forward, since the Fed has telegraphed its intent to normalize policy rates, we don’t expect another Taper Tantrum, and current spreads appear to offer fair compensation, at least on a relative basis.
2. And attractive yields.
Although volatility could persist, yields are attractive relative to other yield-generating instruments. Also, the current incremental pickup in yield relative to volatility looks reasonable as compared to that of fixed income alternatives.
3. Fundamentals remain attractive.