There has been talk recently about the yield of the high yield market, as represented by the various indexes, and if there is return left to be had. While the high yield indexes are representative of the high yield “market,” we do not believe they are representative of the true opportunity in the high yield space.
Let’s breakdown a couple of the widely quoted high yield indexes. The quoted yield-to-worst, generally what people are quoting when they talk about “yield” on the high yield market, on the Barclays High Yield Index is 4.94%. This index consists of 2,162 issues and $1.33 trillion in market value, with a par weighted dollar price of $105.78.
Of that $1.33 trillion in market value, nearly 60% of it trades at a yield-to-worst of 5% or less.1 Similarly, the Bank of America Merrill Lynch US High Index reports a yield-to-worst of 4.98%, with 2,245 individual issues, $1.35 trillion in market value represented, and a par weighted dollar price of $105.72. Here, over 60% of the market value is from bonds that trade at yield-to-worsts of 5% or less.2 With such a large portion of the market at low yields, this is certainly skewing the “average yield” numbers.
Why are yields on such a large portion of the market so low? As we have discussed in the past, due to a wide open new issue market and historically low rates over the past several years, it seems to become a give-in that most the issues will be called at the nearest call price, meaning many often trade at or above this price. As a consequence this leads to low yields, in some cases VERY low yields if the company is current callable. As noted above, with a par weighted average dollar price of $105.78 on the Barclays High Yield Index and $105.72 on the Bank of America Merrill Lynch US High Yield Index3, it is evident that a large part of the market is trading at a premium to call prices.
Above and beyond this, we have seen lots of interest in the high yield market over the past five years, and with that we believe that many investors have become complacent, running up bonds prices and not demanding to get paid commensurate with risk (for an example, see our blog “Avoiding Complacency”). Our experience has been that this is often more evident with the large, most liquid on-the-run names.
So while there is a portion of the market at these historically low yields, as reflected by the “average yields” presented by the indexes, there is also a sizable portion of the market that still offers what we view as attractive yields in good companies. In some cases these can be tranches that are smaller than the $1 billion issuer/$400mm issue or $500 million tranche size that is required to be included by some of the index-based products, or tranches/issuers that are overlooked by investors that rely on Street research on the widely covered names to make investment decisions. Or there may be names that are misunderstood by the market for wrong or temporary reasons.