Credit cycles end badly because of dramatically over-leveraged balance sheets (1990 and 2007) and/or the funding of dubious business models with lots of leverage (1998-2000—Telecom, Media, and Technology, TMT). While broadly speaking within the high yield market we are seeing reasonable value and conservative balance sheets, we have been vocal and adamant that many shale oil and gas producers fit this second broken model with their unsustainable business models and we continue to avoid them, and caution other investors to do the same. Market participants today have ring-fenced this industry and we believe an increase in defaults for this specific industry is unlikely to lead to a blowout in the overall credit market, particularly given where interest rates reside. We believe that those avoiding the entire high yield market because of possible contagion from oil and gas should re-think that strategy.
The high yield bond and loan market has grown up into a large, mature asset class, now together totaling approximately $3.5 trillion3, and that investors can’t and shouldn’t ignore this asset class.
1 Richmond, Adam, Meghan Robson, and Jeff Fong, “Leveraged Finance Insights,” Morgan Stanley Research, June 15, 2015, p. 1.
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. June 26, 2015, p. 5. Spread referenced is spread-to-worst.
3 Blau, Jonathan, James Esposito, and Amit Jain, “Leverage Finance Strategy Weekly,” Credit Suisse Fixed Income Research, July 17, 2015, p. 4, 26.
This article was written by Tim Gramatovich, Research Analyst for Peritus Asset Management, the sub-advisory firm of the AdvisorShares Peritus High Yield ETF (HYLD.