While many often view the high yield bond asset class as a small, niche market, the reality is that this is a large and growing market.1
There have been several distinct periods of growth that assist in understanding the development of this market. Prior to 1985, the market consisted almost entirely of securities that were once investment grade but had since been downgraded. These securities became known as “fallen angels.” It was in the 1980s that Drexel Burnham, and eventually all of Wall Street, began to embrace the concept of original issue high yield bonds to finance everything from leveraged buyouts to significant new industries, including modernizing Las Vegas (Caesars World, Circus Circus, Bally’s), creating cable networks (Turner Broadcasting-CNN) and ultimately even financing the beginning of the wireless age (MCI and McCaw Cellular). It is important to note both then and now that the high yield issuers are not start-up companies, but generally medium- to large-sized companies with well-established product lines or services looking for an alternative form of financing to sustain or grow their businesses.
The high yield market offered several important advantages to issuers. Prior to the original issue high yield market, companies would have to finance themselves with equity and/or traditional bank debt. The problem is that equity financing is often very expensive and massively dilutive to existing shareholders, while bank debt is short term, has amortization payments and comes with restrictive covenants. Bank financing would not be effective in building out the massive infrastructure required in many of these cases. Thus, the long-term nature and fixed coupon payments provided by high yield bonds allowed for the stability needed for these companies, and the market growth began.
However in 1990, the growth of the market stalled as the country entered a significant recession and default rates climbed. Given the limited size and breadth of the market at the time, many wondered whether this asset class would survive. But survive it did and as the country emerged from this period, the high yield market growth resumed. Yet the truly exponential growth in the market would not begin until 1996 and did not take another breather until the end of 2003.
Several factors led to this exponential growth in issuance. First, the asset class gained the attention of many institutional money management consultants as the return profile from 1990-1995 had been very attractive. This demand enabled more companies to raise money in the high yield space versus bank debt or other forms of financing.
This was both good and bad. It did bring in many new players on the issuance side of the market but as the demand grew so did the ability to raise money on fictional business plans, especially in the “TMT” (telecommunications, media and technology) space as the internet and technology bubble developed. Like in the equity market, billions of dollars were raised by companies with no revenues and only a plan for the future. This ultimately led to the second “nuclear winter” in high yield which occurred in 2002, culminating with the high profile defaults of Enron and Worldcom and the collapse of the technology and telecom markets. Once again, a period of healing and consolidation began as issuance subsided. But issuance once again picked up starting in 2006 and the market now stands at over $1.3 trillion and growing rapidly, with record issuance over the past two years.2
Now at $1.3 trillion, the high yield market stands as 14% of all outstanding corporate debt.3 Not to mention that over 2013, high yield issuance was 24% of all corporate debt issuance.4 This is a rapidly growing asset class and has become a much more significant component of the total corporate fixed income space. We feel that investors should be paying more attention to this growing market that provides what we see as an attractive tangible yield for active managers who are able to parse out the best opportunities within the asset class.
1 Blau, Jonathan, James Esposito, and Daniyal Khan. “2014 Leveraged Finance Outlook and 2013 Annual Review,” Credit Suisse Global Leveraged Finance. February 6, 2014, p. 41.
2 Acciavatti, Peter D., Tony Linares, Nelson R. Jantzen, CFA, Rahul Sharma, and Chuanxin Li.. “Credit Strategy Weekly Update.” J.P. Morgan, North American High Yield and Leveraged Loan Research. January 10, 2014, p. 8.
3Date from the publication “Outstanding U.S. Bond Market Debt” release by SIFMA, as of 12/31/13, with $9,766.4 billion in Corporate Debt outstanding.
4Data from the publication “U.S. Corporate Bond Issuance” release by SIFMA, data for 2013.
This article was written by Tim Gramatovich, CFA, Chief Investment Officer for Peritus Asset Management, the sub-advisor to the AdvisorShares Peritus High Yield ETF (HYLD).