There have recently been a few high profile investors that have spoken out against the high yield market, with Carl Icahn among the more vocal. While Icahn may have an agenda or perhaps a short trade in high yield, it is peculiar that he is so vocal against high yield bonds, calling it a bubble, when many of his equity purchases also are high yield issuers, not to mention his Icahn Enterprises is an issuer of high yield bonds.
Looking at Icahn’s top ten equity holdings, over half of them are not rated or high yield bond or loan issuers. If the high yield bonds are so risky, the equities would be infinitely more risky, as equity ranks below bonds in the company’s capital structure and if Icahn’s concern is bankruptcies in this “bubble” market, the bondholders would have to get paid back before there is any value to the equity. If he is concerned about the risk for high yield issuers, his warnings versus his holdings don’t add up.
Above and beyond this, we believe he is very hard pressed to call the high yield market a bubble. As we have written about previously, a bubble implies investors piling into a sector, bidding it up well above its fundamental, intrinsic value. First off, there has been no massive piling into the high yield sector. In reality, high yield mutual and exchange traded fund flows have actually been negative for the last two years. Second, by no means is the high yield market at the sort of ridiculous valuations you see in bubble markets. The current spreads offered by the high yield market of 709bps are nearly 30% above the historical median levels of 546bps.1
Rather than listening to the fear mongering, we believe that today’s high yield market is more than compensating investors for the risks within it, and offers active investors compelling value. Yes, there will likely be some pain to come in certain credits, but active managers are able to do the fundamental analysis to determine the vulnerable companies from the fundamentally sound, undervalued opportunities.