Emerging markets or sovereign debt, is there an opportunity there? We saw the scare earlier this year with various emerging markets. Much of the developed world doesn’t offer rates any better than what we see here in the US…and fundamentally speaking, is Europe really looking better than the US? Even places like Italy and Spain, that have massive deficits and unemployment, are now a trading at yield of 3% and under.3
Not to mention the fact that we have seen some of the countries that have been forced to borrow from the IMF over the last several years now offering bonds at what we would see as pretty thin yields given the quality of the underlying country. For instance in April, Portugal was able to raise over €750 million at a mere rate of 3.575% and Greece was also able to raise €3 billion, in a deal that was well oversubscribed, at a yield of 4.75%. We certainly wouldn’t want to be tying up our money for years at yields under 4-5% in these still tenuous countries.
Turing to corporate credit, we are seeing investment grade bonds offer very little over Treasuries, with spreads over Treasuries at about 100bps and a YTW of 2.96%.4 We have voiced our concerns about this market over the years—the lack of covenant protection causing event risk (meaning a company can add a bunch of debt to the structure without being forced to take existing debt out—all the more of a concern as we are seeing M&A activity pick up), lower durations, and a positive correlation to Treasuries, meaning increased interest rate sensitivity (if you are in the camp that eventually interest rates will be increasing).
Looking the high yield market, there have been concerns that this market is no longer attractive given the yields currently offered. There is a good portion of the high yield market is at very thin yields, with the broad high yield index now reporting a yield to worst of 5.11%.5 However, we certainly don’t see that reflective of true opportunity in the high yield market. By the nature of an average number, you see lots below that level and we are also seeing lots above that level. If you break it down, there is a sizable portion of the market that is trading big premiums at or above call prices, leading to very low yields. As historically low interest rates persist and the refinancing machine cranks on, we don’t see that drag down on the index average yield to worst number easing anytime soon. However, underneath that low headline yield is a good portion of the high yield bond and leverage loan market where we are seeing what we would consider as attractive yields. Active players in the high yield space are able to focus their efforts on this area of the market, where there is seemingly attractive yield to be had, rather than embracing the broader index/market as the passive players do, and forced to take the low yields offered.
So looking at the investment horizon before us, we continue to see certain portions of the high yield bond and bank loan market that can be accessed and parsed out via active management as still offering an attractive opportunity in today’s low yield and high equity valuation world.
1 Butters, John, “Earnings Insight,” FactSet, May 2, 2014, p. 2.
2Shiller P/E as of 5/16/14, http://www.multpl.com/shiller-pe/.
3 Data sourced from Bloomberg, as of 5/6/14.
4 Barclays Corporate Investment Grade Index consists of publicly issued U.S. corporate and specified foreign debentures and secured notes that meet the specified maturity, liquidity, and the quality requirements (source Barclays Capital), data as of 5/14/14.
5 The Bank of America Merrill Lynch High Yield Index, which monitors the performance of below investment grade U.S. dollar-denominated corporate bonds publicly issued in the U.S. domestic market. Index data sourced from Bloomberg, yield to worst as of 5/14/14.